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VAT accounting for mixed business and non-business purposes

October 8, 2008

The issue of VAT accounting when the goods involved are put to both business and non-business purposes is perhaps more widespread than many would first consider.

Careful use of the so-called ‘Lennartz Accounting’ scheme can provide cash flow benefit for a number of organisations.

Here are two examples:

  1. a small home based business purchases specialist woodworking equipment. A Director also uses that same equipment to repair internal doors for local OAPs, free of charge;
  2. a charity purchase computer equipment for its charitable activities, and for its mail order business.

How is input tax calculated at the time of purchase? How is output tax to be calculated when the equipment is later sold on? And what happens in between?

Why have the rules changed?

It all goes back to a European Court decision in 1991, concerning a German taxpayer who purchased a car which was to be used partly for business purposes, and partly for private (non-business) purposes. (Germany does not have the same restriction on input tax on cars that the UK has.) The Court held that he was entitled to recover all the VAT as input tax, and account later for output tax on any non-business use. A later case applied the same ruling to property.

What choices are open to me?

When a VAT registered person purchases goods for use within his business, there is a legal right to recover the VAT as input tax, subject to certain conditions. This also applies when the same goods are also put to non-business use.

  1. he may choose to treat them as wholly non-business, and not reclaim any VAT. There will be no later liability to account for VAT when he sells the goods;
  2. he may treat them as part business, and part non-business, and just reclaim part of the input tax, based on the anticipated business use. This option has the disadvantage that an increase in business use cannot be adjusted for;
  3. he may use the ‘Lennartz Accounting’ scheme. He will claim all the VAT immediately.

What goods does this scheme apply to?

The ‘Lennartz Accounting’ scheme applies to goods, not services. So a telephone bill cannot be subject to Lennartz. However, where services are used to effectively create a new business asset, then Lennartz can apply. In particular, services in the course of certain construction projects:

- construction of a new building or civil engineering work;

- construction of an extension or annex to an existing building, where the footprint of the entire building is increased by 10%;

- reconstruction of an existing building, where the works are so fundamental as to create a new asset.

Whether it is beneficial to fall within Lennartz or not will depend on the exact circumstances.

Output tax under Lennartz

Where a taxpayer uses Lennartz, he can recover VAT in full at the time those goods are received by him. Subsequent non-business use is deemed to be a taxable supply, so he has to account for output tax in each VAT period where there is non-business use, which of course may vary each period. Adjustments have to made throughout the economic life of the asset, normally 5 or 10 years. If the asset is sold or otherwise disposed of during that period, there will also be an output tax charged at that time.

Who can benefit from Lennartz?

Where a taxpayer would normally only be entitled to recover a small proportion of input tax, based on a small proportion of business use, then Lennartz will be useful for cash flow purposes.

Here is an example:

A charity reconstructs a building at a cost of £1 million, plus VAT of £175,000. Its business use is 10%. The ‘economic life’ is 10 years.

Under the conventional method, he would have claimed £175,000 x 10% = £17,500. The remaining £157,500 would have not been recovered.

Under Lennartz, he claims £175,000 immediately. Each quarter he makes an adjustment to reflect 10% business, 90% non-business (charitable) use;

£175,000 x 90% / (10 years x 4 quarters) = £3,937.50.

If the business use increases during the 10 year period, then the calculation is changed to reflect that, Suppose the business use increases to 20%;

£175,000 x 80% / (10 x 4) = £3,500.00.

Although the end result may well be the same, the charity has gained by receiving the full input tax claim at the time of supply, which provides a substantial cash flow benefit. In my own contact with charities, this has been favourably received.

How can I find out more information?

There are details in the VAT Regulations 116A-116N, and in Information Sheet 14/07.

About the Author

Les Howard is a freelance VAT Consultant. He has worked in many types of business, and now specialises largely with charities. He works in association with Elysian Associates Ltd. Visit his website here.