Irrecoverable VAT in the accounts

Q: What mistakes come up most often?

Showing recoverable VAT as a cost. If VAT has been or will be reclaimed, it belongs in the VAT control account, not in expenses or asset cost. Expensing blocked VAT on a car. It is part of the asset's cost and is depreciated with it. Leaving the exempt share in the VAT account. Under partial exemption, the unrecovered part of residual VAT must be cleared to cost, or the control account will not reconcile to returns. Ignoring the annual adjustment at the year end. A significant adjustment due after the year end may need estimating in the accounts. Using the annual adjustment to fix errors. Notice 706 says errors must be corrected separately. Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.

VAT that a business cannot reclaim is part of what the purchase cost it. FRS 102 paragraph 29.20 says expenses exclude recoverable VAT, and irrecoverable VAT on fixed assets and other separately disclosed items is included in their cost where practicable and material. So blocked VAT on a car, the exempt share of VAT under partial exemption, and all VAT paid by an unregistered business is added to the asset or expense it relates to, not shown as a separate tax charge.

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What does FRS 102 require?

Paragraph 29.20 contains three rules:

turnover excludes VAT on taxable outputs, and VAT imputed under the flat rate scheme;
expenses exclude VAT that is recoverable;
irrecoverable VAT allocable to fixed assets and to other items disclosed separately is included in their cost where practicable and material.

The cost rules in other sections say the same thing from the asset side. Paragraph 17.10(a) includes non refundable purchase taxes in the cost of property, plant and equipment, paragraph 18.10(a) does the same for intangible assets, and paragraph 13.6 includes taxes in the cost of stock other than those subsequently recoverable from the tax authorities. The test is recoverability by the business, not whether VAT was charged.

Why might VAT not be recoverable?

There are four common situations.

The business is not registered or makes only exempt supplies

HMRC’s Business Income Manual at BIM31535 explains that where a trader is exempt or not registered, there is no VAT account and the VAT on purchases, including capital items, cannot be relieved. All of it is part of the cost.

Partial exemption

VAT Notice 706 explains that a business can recover in full the input tax on purchases used only for taxable supplies, cannot normally recover input tax directly attributable to exempt supplies, and recovers residual input tax on shared costs and overheads only to the extent it relates to taxable supplies. Under the standard method, the recovery percentage is rounded up to the next whole number unless residual input tax averages more than £400,000 a month. Small amounts of exempt input tax can be recovered under the de minimis rules in section 11 of the notice. See VAT partial exemption and partial exemption de minimis limits.

Blocked input tax

Some VAT is barred whatever the business does. VAT Notice 700/64 says that as a general rule VAT on buying a car cannot be recovered, with exceptions for cars such as taxis and those used exclusively for business, and that 50% of the VAT on leasing a qualifying car is normally blocked. VAT Notice 700/65 blocks input tax on business entertainment, although entertainment for employees is not blocked. See the 50% block on leased cars.

Non business use

VAT on costs used for non business activities is not input tax. The Capital Goods Scheme guidance confirms that VAT on the non business element of an asset is always non deductible.

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How does it work in a set of accounts?

Illustration only. A partly exempt business has a standard method recovery rate of 60%. VAT is at the standard rate of 20%. In one quarter it incurs the following:

Item	Net £	VAT £	Recovered £	Amount in accounts £
Computer equipment used across the business (residual)	10,000	2,000	1,200	10,800 fixed asset
Professional fees, general overhead (residual)	5,000	1,000	600	5,400 expense
Costs used only for exempt supplies	3,000	600	Nil	3,600 expense
Car with private use available	25,000	5,000	Nil (blocked)	30,000 fixed asset
Client entertaining	1,000	200	Nil (blocked)	1,200 expense

The irrecoverable VAT is not posted to a single “VAT written off” line. It follows the cost to which it belongs, so the computer and the car are depreciated on the VAT inclusive amounts. Only the £1,800 actually recovered goes to the VAT control account.

Paragraph 29.20 qualifies the rule with “where practicable and material”. A business with a small, stable irrecoverable amount on overheads may reasonably charge it to a general overheads line rather than spreading it across every expense heading. Irrecoverable VAT on a significant fixed asset should be capitalised.

What happens when the annual adjustment changes the figure?

Recovery under partial exemption is provisional. Notice 706 explains that at the end of each longer period, usually the VAT tax year ending on 31 March, 30 April or 31 May, the business recalculates the recovery percentage for the whole year and makes an annual adjustment. The adjustment goes on the first return after the longer period, or optionally on the last return of the longer period. The notice also says an annual adjustment cannot be used to correct actual errors, which must go through the error correction procedures.

FRS 102 does not set a specific treatment for these adjustments, so the business needs an accounting policy and, under paragraph 10.7, must apply it consistently. Where the VAT year and the accounting year differ, the year end accounts should reflect a reasonable estimate of any adjustment due for the part year. More on the mechanics is in the partial exemption annual adjustment.

How does the Capital Goods Scheme affect cost?

For large capital items, the initial recovery is reviewed over several years. VAT Notice 706/2, as updated in July 2026, applies the scheme to buildings, property interests and civil engineering works with a value of £600,000 or more excluding VAT, and to aircraft, ships, boats and other vessels of £50,000 or more. The adjustment period is 5 intervals for ships and aircraft and 10 for all other capital items. That update also removed computers from the scheme.

If taxable use falls, the business repays some VAT; if it rises, it recovers more. For capital allowances, HMRC’s Capital Allowances Manual at CA29230 explains that an additional VAT liability is added to qualifying expenditure, and an additional VAT rebate is brought in as a disposal value, under sections 234 to 240 of the Capital Allowances Act 2001.

How is irrecoverable VAT treated for tax?

Because the accounts carry irrecoverable VAT as part of cost, the tax treatment usually follows the item. BIM31540 says that for a partly exempt trader the relevant expenditure is inclusive of any input tax that cannot be claimed; irrecoverable VAT on capital expenditure is not deductible but may qualify for capital allowances. BIM31545 confirms that blocked VAT on a car forms part of its cost for capital allowances, and BIM31555 says the VAT on business entertainment is disallowed along with the entertainment itself. BIM31540 also notes that HMRC generally accepts the apportionment agreed for VAT when computing trade profits. The capital allowance side is covered in capital allowances explained.

What mistakes come up most often?

Showing recoverable VAT as a cost. If VAT has been or will be reclaimed, it belongs in the VAT control account, not in expenses or asset cost.
Expensing blocked VAT on a car. It is part of the asset’s cost and is depreciated with it.
Leaving the exempt share in the VAT account. Under partial exemption, the unrecovered part of residual VAT must be cleared to cost, or the control account will not reconcile to returns.
Ignoring the annual adjustment at the year end. A significant adjustment due after the year end may need estimating in the accounts.
Using the annual adjustment to fix errors. Notice 706 says errors must be corrected separately.

Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.