What is de minimis VAT? The de minimis rules, limits and tests explained

What is de minimis VAT?

De minimis is a VAT partial exemption rule. If your business makes some exempt supplies (residential rent, financial services, some education or healthcare), you normally can't reclaim the VAT on costs linked to that exempt income. The de minimis rule says that if this "exempt input tax" is small, you can reclaim all of it anyway.

The VAT de minimis limit has two parts, and you must meet both:

• exempt input tax is no more than £625 per month on average (£1,875 a quarter, £7,500 a year), and
• exempt input tax is no more than 50% of your total input tax.

HMRC also offers two simpler checks (Tests 1 and 2 below) that let many small businesses skip the full calculation. The rules are set out in HMRC's VAT Notice 706: partial exemption.

Exempt vs zero-rated vs outside the scope

Three terms that get confused, often in the same conversation:

• Standard-rated supplies attract VAT at 20% (or the reduced rate of 5%). Examples: most goods and services.
• Zero-rated supplies are taxable but charged at 0% VAT. Examples: most food, children's clothes, books. The business can still recover VAT on costs.
• Exempt supplies don't attract VAT at all. Examples: residential rent, certain types of education, financial services, some healthcare. The business cannot normally recover VAT on costs that relate to making exempt supplies.
• Outside the scope supplies aren't UK supplies for VAT purposes. Examples: services to overseas business customers under the place-of-supply rules.

If your business makes both taxable supplies (standard or zero-rated) and exempt supplies, you're partially exempt, and the de minimis rules are the first thing to check.

Who is partially exempt without realising it

• Charities with trading activities: much charitable income is exempt or non-business, the trading is taxable
• Property businesses: commercial lettings can be opted to tax, residential lettings are exempt; mixed portfolios trigger partial exemption
• Medical practices: clinical services are exempt, but some retail sales are taxable
• Financial services firms: most financial intermediation is exempt, but consultancy or training may be taxable
• Education providers: tuition is often exempt, but commercial conferences and trading activities are taxable

The three kinds of input tax

Every de minimis test uses the same building blocks, so it helps to sort your VAT on costs first:

• Directly taxable: VAT on costs used only for taxable supplies (stock you sell with VAT). Always recoverable.
• Directly exempt: VAT on costs used only for exempt supplies (repairs to a residential flat). Not recoverable unless you're de minimis.
• Residual: VAT on shared overheads (rent, accountancy, software). Split between taxable and exempt using your partial exemption method.

Exempt input tax = directly exempt + the exempt share of residual.

The simplified de minimis tests

Before doing any apportionment, check Tests 1 and 2. Pass either and you're treated as de minimis for that period: recover everything.

Test 1

• Total input tax is no more than £625 per month on average, and
• the value of exempt supplies is no more than 50% of the value of all your supplies.

Example: a landlord-trader has £1,500 of input tax in a quarter (£500 a month). Sales are £40,000 taxable and £15,000 exempt rent, so exempt supplies are 27% of the total. Test 1 passes. All £1,500 is recoverable.

Test 2

• Total input tax minus input tax directly attributable to taxable supplies is no more than £625 per month on average, and
• the value of exempt supplies is no more than 50% of the value of all your supplies.

Example: a business has £4,200 of input tax in a quarter (£1,400 a month), so Test 1 fails. £2,700 relates directly to taxable sales, leaving £1,500 (£500 a month). Exempt supplies are 20% of all supplies. Test 2 passes. All £4,200 is recoverable.

The full de minimis limit

If both simplified tests fail, do the partial exemption calculation (the standard method, or a special method agreed with HMRC), then check the de minimis limit on the result: exempt input tax no more than £625 a month on average and no more than 50% of total input tax.

Worked example

A small medical practice with retail sales, figures for the year:

• Total input VAT: £8,000 (£667 a month)
• Directly taxable (retail stock): £3,000
• Directly exempt (medical equipment): £1,000
• Residual (rent, utilities, admin): £4,000

Test 1 fails: £667 a month is over £625. Test 2: £8,000 − £3,000 = £5,000, or £417 a month, which is under £625. But if exempt supplies are more than half of all supplies, as they usually are for a practice, Test 2 fails too.

Standard method: say taxable supplies are 35% of all supplies. Recoverable residual = £4,000 × 35% = £1,400; exempt residual = £2,600.

Exempt input tax = £1,000 + £2,600 = £3,600, or £300 a month (under £625), and 45% of total input tax (under 50%). The practice is de minimis and recovers all £8,000.

At a 25% recovery rate instead, exempt residual becomes £3,000 and exempt input tax £4,000: exactly 50%, still within the limit. A little lower and the practice would fail, recovering only £3,000 + the taxable share of residual.

The annual test and the annual adjustment

Each VAT period's de minimis result is provisional. At the end of your partial exemption year, apply the tests to the full year's figures. If you were treated as de minimis during the year but fail on the annual figures, the annual adjustment repays the over-recovered VAT, and the reverse can also happen.

HMRC also allows an optional annual test: if you were de minimis in the previous year, you may treat yourself as de minimis provisionally in each period of the current year, then check at year-end. Conditions apply (including expected total input tax under £1 million); see Notice 706.

This is where the trap lies. A business that grows its exempt costs during the year, or makes a large purchase in one quarter, can find the annual recalculation triggers a payment back to HMRC.

Quick checklist

1. Do you make any exempt supplies? If no, partial exemption doesn't apply. Stop.
2. Run Test 1. Pass: recover everything for the period.
3. Run Test 2. Pass: recover everything for the period.
4. Otherwise, do the partial exemption calculation and check the de minimis limit (£625 a month and 50% of input tax).
5. Within the limit: recover everything. Over it: recover directly taxable VAT plus the taxable share of residual.
6. At year-end, repeat with full-year figures and post the annual adjustment.

Where this gets hard

The rules fit on a page. Applying them cleanly across every VAT period, with transactions moving in the ledger, the annual recalculation and an audit trail intact, is the hard part, and the standard accounting platforms don't help with it.

That's the gap OneSixth fills: it sorts input tax into taxable, exempt and residual, runs the de minimis tests each period and at year-end, and keeps the working papers.