Making Tax Digital

Rural businesses VAT partial exemption and MTD

Making Tax Digital (MTD) has resulted in businesses being best advised to transition over to using computer systems to aid the processing of their day-to-day transactions.  MTD for VAT purposes is now in operation and MTD for Income Tax purposes is due within the next couple of years.  As with any system of bookkeeping and more so with any computer system, the correct processing of data is key, otherwise the saying “Garbage in and Garbage out” applies.



29th September 2021

In processing your own data, you need to become a proficient bookkeeper, if you do not wish to invest in the skills of a professional.  Whilst cloud computer systems have aided the processing of business transactions, with bank feeds, and the use of apps, like Dext to upload e-mailed and scanned invoices into the likes of the Xero system, the ability to process your data is a lot more involved than just using a keyboard.

At Old Mill we would recommend the Xero product and related applications to help clients with the processing of their business income and expenditure, using sufficient nominal codes to correctly analyse data to aid their understanding of their business performance and to provide sufficient detail to aid the production of accounts and tax returns compliant for tax purposes.

Bookkeeping may seem to be straightforward, however, this thinking is a folly.  Many rural businesses have had to diversify over the years to enhance the overall income for the business.  One of the simplest forms of diversification is to let property not required for business purposes.  This can have a significant effect on the record keeping, as it can result in the business falling within the Partial Exemption regime for VAT purposes.

Our experience is that many businesses do not understand how this affects their VAT Returns and many would therefore be completed incorrectly.  Whilst moving towards MTD you would be forgiven for thinking that once the computer has provided the reports of the transactions posted, that that data is then in a suitable condition to submit it through the MTD system.  However, this is far from the case.  Where a business is regarded as “Partially Exempt”, the submission of that data directly from your system may result in you submitting an incorrect VAT Return.  Partial exemption calculations must be carried either automated in your system or can be done outside of the automated VAT return steps required by MTD, and any adjustment required can be applied as a ‘manual’ step after your system has prepared the draft VAT figures.

It is therefore important to appreciate the impact on your VAT position if your business activities fall within the Partially Exempt regime.  Where you do fall into this, you are required to classify your VAT on expenditure to identify if any VAT recovery restriction should apply under the partial exemption rules.

In processing your data, you need to first identify the income that your business receives.  Some of the income of the business will relate to the making of taxable supplies.  Such supplies would be where you apply the following taxable rate of VAT:

  • 20% standard rate of VAT,
  • 5% reduced rate VAT,
  • 0% zero rate which would apply to many farming businesses.

Income to which a zero rate would apply, would include the sale of milk, livestock and cereals.

Income to which the standard rate would apply, would include the provision of contracting services, the supply of furnished holiday letting and storage containers.

However, where your business may now also be renting out a barn or some land which have not been ‘opted to tax’, or the residential renting of a cottage no longer required for staff, then that business income is VAT Exempt.

The moment this happens, you need to be very careful when processing the expenses of your business.  It is therefore important to recognise that your business expenditure would now fall into three different categories:


  1. Expenditure that you would incur and would be directly attributable to making your taxable supplies. This, for example, would be the fertiliser that you would purchase in order to grow the cereal crop, or the vet you would pay in order to help you look after your livestock.  Input VAT on these costs is recoverable in full.
  2. Expenditure that you would incur and would be directly attributable to making your exempt supplies. This for example may include repairing the property you derive your exempt rental income from, and the agents’ fees for collecting the rent. This is ‘Exempt Input VAT’ and may not be recoverable.
  3. Expenditure that could be attributable to both elements of your business activity. For example, the costs of running the vehicles you use in your farming business and to acquire materials to maintain or repair the let properties.  Professional fees may in part relate to both enterprises, like accountancy fees, which are incurred to produce your accounts which not only calculate your trading result but also your investment income arising from your letting business.  Other expenditure would include such overhead items like telephone and advertising costs. VAT on these costs may only be partially recoverable.

The third type of expenditure above is referred to as your Residual Expenditure and requires a calculation to identify how much of it is attributable to your exempt activities.  Therefore, it is important, when setting up your posting into your computer system, that you can designate such items of expenditure into the three categories above.  This will save a lot of time when you come to do your partial exemption checks.

The amount of VAT in the residual category attributable to making exempt supplies can be calculated using the standard method, which does not require approval from HM Revenue and Customs (HMRC).  This is simply to look at the ratio your exempt supplies i.e. rental income, relate to your total supplies, which includes your taxable supplies.

Once you have categorised your transactions into those three elements, mentioned above, it is important to recognise that if the total of the VAT that is attributable to the making of exempt supplies is greater than £625 per monthly VAT Return, then that VAT is not recoverable at all, even though you may have recorded it in your system.

If your total exempt VAT for the monthly VAT Return falls below £625, then you also must ensure that the amount of Exempt VAT is less than the VAT that you are expecting to claim on taxable supplies.  There is always an annual adjustment to do which could result in previous VAT that was recovered now being repayable to HMRC, or likewise meaning that any VAT you temporarily could not recover, being reclaimable.

At Old Mill we have a specialist team that can undertake bookkeeping for our clients. If you require assistance with this calculation, please contact your adviser who will arrange to discuss with you the assistance we can give, or alternatively click here…