Are you including too much income in your calculations?

Partial exemption

If your business has some taxable income, i.e. sales subject to 0%, 5% or 20% VAT, and some exempt sales, it is partly exempt. You cannot claim input tax on any expenses that directly relate to your exempt sales and must apportion the VAT you claim on mixed costs and general overheads.

Example. If you use the services of a VAT- registered subcontractor and they do work relating to both your taxable and exempt activities, this is a mixed cost. General overheads would include, e.g. accountancy fees, computer costs, telephone bills, premises costs. Overheads and mixed costs are referred to as “residual input tax” in HMRC’s guidance, VAT Notice 706.

If your business qualifies as de minimis at the end of a period, i.e. the input tax relevant to your exempt activities is below certain limits, you can claim it all anyway.

You must always do an annual adjustment up to 31 March, 30 April and 31 May each year, depending on your return periods. The relevant date is 31 March if you submit monthly returns. The annual calculation always supersedes the input tax claimed on your monthly or quarterly returns submitted during the year.

Standard method

Most partly exempt businesses use the standard method of calculation, based on turnover splits, i.e. (taxable sales (ex. VAT)/taxable sales (ex. VAT) + exempt sales) x 100. This calculation is carried out at the end of each period and then for the annual adjustment as explained above.

If your residual input tax is less than £400,000 each month on average, which will usually be the case, you can round up the percentage to the nearest whole number, e.g. 78.1% becomes 79%.

What income is excluded?

You should only include income from your main trading activities in the standard calculation, so will exclude the following sources:

• sales of capital assets, including sales of property, vehicles and computers.
• bank interest and dividend income as long as they are not linked to a primary trading activity, e.g. passive interest earned on a deposit account is excluded
• money received from the issue of new shares in your company because they are not supplies for VAT purposes.

Trap. All sales of capital assets are excluded, not just those that come within the capital goods scheme, which is a separate issue.

Share sales: updated guidance

HMRC updated VAT Notice 706 on 16 December 2025 regarding share sales, following the outcome of a long-running tribunal case which was heard in four different courts.

Sale of shares. If your company receives income from share sales, perhaps from an investment in a subsidiary company, this is an exempt supply and any input tax you incur on, say, professional fees linked to the sale, cannot be claimed because they relate to that supply. The fact that you might use the sale proceeds to invest money into a taxable business is irrelevant.

Standard method. You must exclude the proceeds from the calculation because it is incidental to your main business activity.