Changes and challenges to partial exemption special methods

With the standard VAT year ends (March, April or May) having just ended, partially exempt housing associations will have performed, or will shortly perform, the mandatory annual adjustment calculation. The annual adjustment can be included in either the last VAT return period of the VAT year or the first VAT return period following the end of the VAT year.

At the time of completing the annual adjustments, housing associations often have an opportunity to consider whether their existing partial exemption VAT recovery method accurately measures the use, for VAT purposes, of expenditure across the organisation, as well as the wider group of organisations if the housing association has other connected companies – for example, a trading subsidiary.

As a reminder, the ‘standard’ partial exemption VAT recovery method, which is an income based method, must be used unless an alternative method is agreed and approved by HM Revenue and Customs (HMRC) – a so called partial exemption ‘special’ method (PESM).

Some sectors, such as the social housing sector, are rather complex for VAT purposes, and the standard partial exemption method does not always give a fair and reasonable result. To support the agreement of a PESM, HMRC has published a number of sector focussed frameworks for PESMs. They are intended to allow PESMs which are fair and consistent to be agreed, with the minimum amount of time and cost to both the applicant and HMRC.

For housing associations, the Framework for Housing Association Partial Exemption Special Methods which was published in 2014 can be used and referred to if seeking to agree a PESM with HMRC. We are aware that HMRC are updating the Framework, and we have been advised that a draft will be shared with the sector for comments prior to it being issued.

It is not uncommon for housing associations to need to update an existing agreed PESM for different reasons. For example:

  • New income streams or activities may not be dealt with appropriately by the existing method.
  • Existing income streams or activities on which a PESM is based may cease.
  • For VAT groups, it may be a requirement of a PESM approval from HMRC that an entity joining or leaving a VAT group requires the PESM to be updated.

A request for an update to a PESM must be submitted to HMRC in the same way as a brand new PESM (i.e. where there was not a PESM previously agreed).

This means that all elements of a PESM will be considered and reviewed by HMRC, even if those elements were approved by HMRC as part of a previous PESM approval. 

We are now seeing examples where applications for PESMs are being rejected by HMRC, but the areas of concern for HMRC in the current applications were previously approved by HMRC for the existing PESM which the housing association is seeking to update.

There may be legitimate and obvious circumstances where part of a previously agreed PESM is no longer reasonable or accurate, and it is appropriate for HMRC to challenge it. However, our experience is that there are also instances where there does not appear to be any changes to the circumstances on which the previous PESM was approved by HMRC. In a number of instances, the existing PESM is in line with the 2014 Framework, so it is not clear why this is the case. As a result, housing associations are being left in a position where they are unclear on what will be acceptable to HMRC, and PESM applications are becoming more drawn out and costly – contrary to the purpose of having a published framework.

Next steps for housing associations

Housing associations should monitor their VAT recovery method to ensure it continues to provide a fair and reasonable means of apportioning VAT incurred on expenditure. We suggest that this is done following or alongside the annual adjustment.

If your housing association is in the process of, or may shortly be, preparing an application for an updated PESM to HMRC, then it should ensure that it also gives due care and attention to any parts of the PESM which were previously agreed by HMRC. The existing 2014 Framework, notwithstanding the recent experience of housing associations detailed above, can be used as a guide and reference point when applying for the updated PESM.

The key when determining any new PESM is to ensure that due consideration is given to how the overhead costs are used and consumed by the organisation. For example, if all of the costs relate to the overall operations of the housing association, then a single calculation is likely to produce a fair and reasonable allocation. If, however, some of the costs are only consumed by an area of the business, for example commercial property portfolio, or wholly relate to one of the entities within a group registration, then a ‘sectorised’ method may be more appropriate.

The NHF is engaging with HMRC to discuss the experiences members have had in agreeing PESMs with HMRC. To help inform more constructive discussions with HMRC, please get in touch if you are able to share any experiences of challenges in agreeing a PESM with HMRC.

We are hopeful that these discussions will help to shape HMRC’s approach and the form the new version of the Framework, and that this will remove the challenges currently being experienced by housing associations.


RSM is a leading provider of audit, tax and consulting services, with around 3,800 partners and staff in the UK. We're working with our tax advisors RSM to help shape government policy on taxation as it affects the sector and to keep housing associations informed of key issues.

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Who to speak to

Adam Gravely, Finance Policy Officer