VAT annual adjustments: What it is and when to do it

Every year, partially exempt organisations face a vital VAT compliance task: partial exemption VAT annual adjustments. In our latest Insight, our Dains Group colleage Ian Brown outlines why organisations should be preparing now for their annual adjustment and suggests ways to avoid costly errors. 

If your organisation hasn’t completed its annual adjustment yet, now is the time to prepare and reflect on any changes during the year which may need fed into the calculation.

Correctly performing VAT annual adjustments is critical to ensuring VAT compliance and maximising VAT recovery. Yet, many organisations fail to complete this calculation or apply outdated or unauthorised methods – leaving themselves vulnerable to costly errors and HMRC scrutiny.

What are VAT annual adjustments? 

Annual adjustments are year-end recalculations of VAT recovery for organisations that carry out both taxable and exempt activities. 

Normally, an organisation will perform partial exemption calculations in the return for each monthly or quarterly VAT period. The annual adjustment process involves performing the calculations again for the whole of the recently completed VAT year (normally ending March, April or May, depending on the VAT return stagger or frequency).

The recoverable VAT calculated in the annual calculation is then compared to the value of VAT recovered in each VAT return, and the difference recovered from, or paid to, HMRC.

Concerned about your VAT annual adjustments? Contact imagine@hurst.co.uk for an initial chat about how we can help you get on top of your VAT calculations. 

What if expenses have been put to a different use?

The annual adjustment is also the time when the use of expenses should be reconsidered. For example, if VAT on an expense is blocked from recovery on the basis it would be used wholly for exempt activities, but it was then partly or wholly used for taxable purposes, this should be reflected and additional VAT recovered in the annual adjustment.

Additionally, the de minimis thresholds, which can allow full VAT recovery if the amount to be restricted is low, should be re-evaluated using the full VAT year’s values.

Common VAT annual adjustment errors and risks

When done correctly, the annual adjustment ensures the correct amount of VAT is being recovered. However, we often see errors occurring in areas such as:

• Using a method not approved by HMRC
• Failing to exclude certain transactions from the calculations, such as incidental land/property and financial transactions
• Lack of audit trail for de minimis status
• Incorrect attribution of expenditure to taxable, exempt or mixed-use activities
• Failing to perform the annual adjustment at the right time, or in some cases at all.

Are there VAT simplifications to consider for the year ahead?

The VAT annual adjustment is also an opportunity to consider whether VAT simplifications are available or preferable for the new VAT year. Examples include: 

• Using the previous year’s VAT recovery rate as the provisional rate in each VAT period of the current year, or
• Assuming the previous year’s de minimis status will continue (if applicable). 

This can reduce the administration of each VAT return and, for organisations with seasonal fluctuations in trade, reduce the likelihood of an unbudgeted payment at the following annual adjustment.

How can HURST help with your VAT annual adjustments?

Our Indirect Tax team can support your organisation to prepare or review its VAT annual adjustment calculation. We’ll check if it is being performed accurately at the right time, or identify if there are any VAT efficiencies that could be implemented going forward.

For an initial discussion about how HURST can help your organisation with its annual adjustment, please email imagine@hurst.co.uk