Partial Exemption – Incidental Supplies

Our client is a property owner with several properties in his portfolio, including a number of residential rental properties; some opted to tax commercial properties and some FHLs.

As the rent received from the residential properties is exempt from VAT, my client is partially exempt, and I am currently looking at his partial exemption calculations.

He receives bank interest, which is exempt from VAT, from a couple of different bank accounts:

Account 1 is his usual business current account, where he holds his general day-to-day business funds.

Account 2, which is a separate account where only tenant deposits are held.

I am unsure whether it is correct to consider all of this interest as an ‘incidental financial transaction’ and so exclude it from his turnover figures in his partial exemption calculation, as per HMRC’s guidance in section 4.8 of VAT Notice 706.

HMRC’s guidance in section 4.8 of VAT Notice 706 vaguely defines when a transaction qualifies as ‘incidental’ and can be excluded from the partial exemption turnover calculation.

A better understanding of HMRC’s likely position is perhaps better gained from HMRC’s manual PE32000 (link at the foot of this article), which, while still not entirely definitive, also references and comments on leading and important tribunal cases on the matter, particularly the European cases of Regie Dauphinoise & EDM.

Generally speaking:

• The case of Regie Dauphinoise, which HMRC tends to rely quite heavily upon, established that interest received as a “direct, permanent, and necessary extension of” business activities cannot be incidental and thus is not excluded from the turnover figures used in the partial exemption calculation.
• The case of EDM established that, when considering whether the receipt of interest can be considered incidental and thus excluded from partial exemption, it is not unreasonable to take into account the amount of taxed cost involved in generating the interest, but the ruling itself left each EU nation to consider and interpret its practical application to individual cases, so it was not perhaps as helpful as it may have been.

Applying the above case law, and in particular that of Regie Dauphinoise, to the interest received by your client. It is reasonable to assume that in regard to interest received regarding Account 1, this interest is simply received due to holding the business’s general business funding in this account, and so it may be reasonable to assume HMRC’s agreement that the receipt of this interest is incidental and thus excluded from the turnover figures in your client’s partial exemption calculation.

However, in regard to Account 2, which only holds tenant deposits, it seems likely that HMRC will consider this interest to have a direct link to and be part of the client’s specific business activity of letting property (the charging and holding of a tenant’s deposit, generating interest from this holding), thus not incidental and thus not excluded from the client’s partial exemption calculation.

PE32000 – Partial Exemption methods: exclusions from the standard method and incidental supplies – HMRC internal manual – GOV.UK

For more information, please contact us at: consultancy@vantagefeeprotect.com