How to support a Partial Exemption Special Method application to HMRC

We’ve previously explained that the default VAT recovery method which must be used is an income-based method, known as the ‘standard’ partial exemption VAT recovery method. However an alternative method can be agreed and approved by HMRC – known as a partial exemption ‘special’ method (PESM).

The NHF has held discussions with HMRC following feedback from members that there was an increasing number of PESM applications which were being rejected by HMRC. The rejection of these applications have left housing associations in a position where they are unclear on what will be acceptable to HMRC. This is despite there being a published Framework for Housing Association Partial Exemption Special Methods which can be used and referred to if seeking to agree a PESM with HMRC.

While we are aware that HMRC are updating the Framework, and a draft will be shared with the sector for comments in due course and prior to it being issued, the discussions between the NHF and HMRC has highlighted some ways in which a housing association can support HMRC in reviewing a PESM application.

How to support a PESM application

Methods of apportionment

A requirement for a PESM is that it is more accurate than using the default income-based standard method. Therefore, a reasonable starting point is why the standard method does not provide a fair and reasonable result.

When proposing a PESM to HMRC, it is helpful to demonstrate the thought process you went through in determining the proposed PESM. What other methods were considered? Why did they not provide a fair and reasonable result? How does the proposed method fit with the Framework? This shows that due care and consideration has been given to a proposed PESM and should demonstrate to HMRC that the proposed PESM is the most appropriate.

If your housing association is applying to HMRC for an update to an existing PESM, this is effectively a request for a brand new PESM. You should ensure that you give due care and attention to any parts of the PESM which were previously agreed by HMRC and not just the updated parts. For example, is a method of apportionment previously agreed still appropriate and accurately measurable.

Example calculation 

It is already common practice to submit an example calculation. However, this is often on a straightforward spreadsheet with little narrative, meaning it can be difficult for HMRC to interpret or understand the calculations. It can also make it difficult to verify that the example calculation is being performed in line with the method described in the PESM application.

It would also be helpful to provide a calculation under the standard method. This provides a reference point for the requested PESM and will often demonstrate and support why the standard method does not provide a fair and reasonable result for VAT recovery.

If practical, an example calculation for PESMs that have been considered and rejected could also be included with the PESM application.

Use of inputs

The aim of a PESM is to ensure that VAT on expenditure is recovered to the extent it is used to make taxable supplies. Whilst a PESM is not an exact science, it must ensure a fair and reasonable apportionment of overhead costs to the making to taxable supplies. It is therefore important to explain to HMRC how inputs are used in making taxable supplies. In particular, this is most helpful where inputs are partly used in making high-value, lower volume taxable sales (i.e open market sales) where, without further explanation, it may seem that there is less input required to make those taxable sales.

This can also be a difficult area to try and find a balance as there will inevitably be inputs within a section of a PESM where the VAT recovery rate may not entirely reflect the taxable use. Consider and explain why you believe you have reached a fair and reasonable point of ‘granularity’ in splitting inputs to reach an overall balance between fair and reasonable VAT recovery without making the complexity of the PESM excessive.


A PESM is binding on the organisation and HMRC. Consequently, both parties need to be comfortable that the PESM agreed is suitable for the upcoming plans of the housing association as well as its current activities.

Explaining in a PESM proposal any known or intended changes to the housing association’s activities, or even stating that they are not intended to change, will give HMRC some comfort that the PESM has been considered for the longer term or can deal with any proposed changes in the organisation. Applying for a PESM can be complex and time consuming, so it is worth avoiding putting yourself in a position where you may need to go through the process again within a few years.

Don’t make assumptions

There is no such thing as a typical housing association. Housing associations vary enormously, both in their size and their range of activities, so do not make assumptions on what HMRC may or may not know, understand or have seen before. Explain the details of your organisation as though it is the first time HMRC will have seen it.

Finally – don’t forget the basics

Make sure you include all required parts of the application, such as the fair and reasonable declaration. It is frustrating to have a PESM rejected, or its consideration delayed as a result of failing to include all the requirement parts of a PESM application in the submission.

This can lead to PESM negotiations with HMRC starting on the wrong foot. Take the time to make sure that the PESM application has all the required parts, is clear and easy to follow.

PESM’s are complex and so it is important that time is taken by both housing associations and HMRC in proposing and reviewing a proposed method. However, following these steps will hopefully support both parties in gaining comfort in a more timely manner that the PESM proposed is suitable for the housing associations activities now and in the future.


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