VAT Recovery and the Annual Recovery Rate Adjustment
As the deadline approaches for businesses to finalise and adjust their VAT recovery rates for the year, the below provides a refresher on the key rules governing partial exemption and VAT recovery in Ireland.
Under Irish VAT legislation, a VAT registered person is entitled to deduct input VAT that relates to its deductible activities (i.e. taxable supplies on which VAT is accounted and qualifying activities). Input VAT that relates to non-deductible activities (exempt and non-qualifying activities) is not deductible.
Where a person is engaged in both deductible and non-deductible activities, input VAT is deductible to the extent it relates to the deductible activities. In the first instance, this involves identifying which costs can be linked to a specific supply or income stream (“direct attribution”) and, where costs cannot be linked to a specific supply or income stream (“general overheads”), recovering a percentage of the VAT based on an appropriate recovery rate which reflects the use of the costs for deductible activities.
Direct Attribution
As outlined above, the first step in the VAT recovery process is to directly attribute input VAT where possible to a particular activity. VAT on costs that are directly attributable to a deductible activity are recoverable in full. While VAT on costs directly attributable to non-deductible activities is not recoverable.
Recovery Rate and General Overheads
Residual costs that cannot be directly attributed to a particular deductible or non-deductible activity are treated as general overheads of the business and are subject to the partial exemption rules where a percentage of the VAT incurred is recovered based on an appropriate recovery rate.
The default recovery method is a turnover based approach which compares turnover from income sources which permit VAT recovery to total turnover.
Recovery rate = Deductible turnover (i.e. deductible income sources such as taxable supplies and qualifying activities) ÷ Total turnover (i.e. all turnover)
Alternative methods other than turnover may be used where the turnover method does not:
In such circumstances, an alternative method (e.g. floor space, employee numbers, staff hours or transaction volumes) may be applied provided it ensures the above.
Provisional Recovery Rate and Annual Adjustment
During the course of the year, businesses typically recover VAT on general overhead costs using a provisional recovery rate. This is generally based on the recovery rate calculated using the prior year’s turnover or, in the case of start-ups or new activities, a reasonable estimate. The provisional rate is applied in periodic VAT returns to allow for ongoing VAT recovery throughout the year.
Irish VAT legislation requires an annual adjustment to the VAT recovered using the provisional recovery rate at financial year-end. This involves recalculating the actual recovery rate percentage for the year using actual amounts and comparing it to the provisional recovery rate applied during the year to determine whether additional VAT is refundable or payable.
Any difference between VAT recovered provisionally and the VAT which is recoverable using the actual recovery rate should be adjusted in the first VAT return following the year-end (typically the January/February return if the financial year-end is 31 December). By concession, Revenue permits the adjustment to be included in any of the 3 VAT returns following year-end (i.e. if the financial year-end is 31 December, the VAT adjustment may be made in the January/ February, March/ April or May/ June VAT return). As the May/ June VAT return is not due for filing until 23rd July, this gives significant additional period in which to calculate and settle any adjustment.
Statutorily Non-deductible VAT
It should be noted that VAT may not be recovered on certain costs for most businesses unless operating as traders in those sectors (e.g. food, drink, accommodation, petrol etc.). Such VAT is irrecoverable regardless of the nature of the supplies or income it relates to.
We can assist you in assessing your business’s annual VAT recovery rate, carrying out a review of methodologies and recovery rates used, ensuring these are appropriate and reflect current business activities. Ensuring appropriate methodologies are adopted not only reduces the risk of non-compliance, but can also maximise cashflow for the business. For more information and a personalised approach to any of the above services, reach out to our team today.