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.
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.