Here are some practical tips for accounting for VAT partial exemption on Xero.
What is partial exemption?
A basic principle of VAT is that you can only reclaim VAT that relates to “taxable supplies”. A “taxable supply” is a sale or other income line where you charge VAT. If you only sell products where you charge VAT, then you can reclaim all of your VAT as a business. However, if you have sources of income that do not attract VAT – for example residential rent or grants – then you cannot reclaim all of your VAT.
I am not going to go into further details of partial exemption methods or calculations – that’s for HMRC to explain in pages of copious guidance.
There are essentially three parts of the process. Firstly, recording the VAT correctly, secondly carrying out a partial exemption calculation and finally adjusting the VAT return. This process applies whichever system you use, however this post sets out how it applies to Xero.
I had a fun challenge recently – accounting for a property purchase in Xero where a third party had paid grant funding directly to the vendor. As it took me a while to work it out, and I couldn’t find what I was looking for online, I thought I’d set it out here.
Some of this advice also applies if you need to account for any kind of purchase where a third party has paid the supplier directly. Or if you are accounting for a property purchase in Xero where you have already paid a deposit but only received an invoice at completion. This post assumes that you have reasonable prior knowledge of accounting for invoices, bills, receipts and payments in Xero.
Even small charities can have big complexities when it comes to choosing and using accounting systems.
There are two issues in particular which can be hard for charities to deal with on many accounting systems. The first is VAT partial exemption. Charities may have a mix of exempt income (grants, donations) and taxable income (eg selling goods or running a cafe). This means that they cannot reclaim all of their VAT and have to do “partial exemption” calculations.