When to apply for a partial exemption special method

Q: What might a special method look like?

Illustration only. A firm earns £300,000 of taxable fees that take most of its staff time and £700,000 of exempt commission that needs little work. The standard method gives 30% recovery on £40,000 of residual input tax, or £12,000. Timesheets show 70% of staff time is spent on the taxable work, and the firm's overheads are mainly office and staff costs. A staff time method would recover £28,000. Residual input tax is under £50,000, so the override cannot correct this. The firm proposes a staff time method, supported by two years of timesheet data, a comparison with the standard method and a signed declaration. A holding company or group with mixed activities would more likely need a sectorised method. If HMRC opens a check into your return, tax investigation insurance pays your accountant's fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

Apply for a partial exemption special method when the standard method, which splits residual input tax by the value of taxable and exempt supplies, does not fairly reflect how your costs are used and you can show an alternative that is more accurate. You apply through HMRC’s online service with a proposal, a worked example, your latest annual adjustment and a signed declaration that the method is fair and reasonable. Until HMRC approves the new method in writing, you must keep using your current one.

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What is a partial exemption special method?

A special method is any way of calculating recoverable input tax other than the standard method (VAT Notice 706, paragraph 6.1). It is unique to your business and is approved or directed by HMRC under regulation 102 of the VAT Regulations 1995. The method must be in writing, and an approval only has effect if it is a written document that identifies itself as an approval (regulation 102(1A) and (5)).

Where the standard method uses the value of supplies, a special method can use other measures. Notice 706 (paragraph 6.6) lists output values, numbers of transactions, staff time or numbers, inputs, floor area, cost allocations and management accounts. Larger businesses often use a sectorised method, which allocates residual input tax to separate parts of the business and apportions each part on its own basis. The recovery percentage in a special method is calculated to two decimal places (paragraph 6.7). Since 1 January 2011 a combined method can also cover business and non business apportionment.

For the basics of attribution and the standard method, start with our guide to VAT partial exemption.

When does the standard method give an unfair result?

HMRC’s Partial Exemption manual (PE41500) groups the problems under three headings:

Distortion from output values. Very high value supplies that use few overheads, such as rent collected through an agent or occasional sales of securities, inflate one side of the fraction. High value, low margin supplies do the same in a less extreme way. Sometimes residual costs are used for only some of the supplies but the standard method spreads them across all of them.
Timing differences. Costs are incurred in one year for supplies made in a later year, so the year’s supply values bear no relation to the year’s spending.
Interdependence. Supplies with different VAT liabilities depend on each other in ways a simple value split does not capture.

Notice 706 (paragraph 5.5) adds separate business units that use costs in different ways, and costs for an intended supply that never happens. But PE41500 is clear that spotting a fault is not enough. You need to show that the distortion is significant and that your alternative guarantees a more accurate result.

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Should you try anything before applying?

Check first whether the problem is already dealt with.

The standard method already excludes sales of capital assets, incidental financial and real estate transactions and self supplies (paragraph 4.8). Many distortions disappear once these are removed.
A new partly exempt business can use the use based option for its registration period or first tax year without HMRC approval (paragraph 4.6).
If residual input tax exceeds £50,000 a year, the standard method override already forces a use based correction where the difference is substantial. Notice 706 (paragraph 5.13) suggests a special method if you find yourself making override adjustments regularly.

HMRC’s guidance to its own officers (PE42500) warns that some proposals are chosen because they give the highest recovery, and tells officers to ask which other methods were considered and why they were rejected. Model the alternatives honestly before you choose one.

How do you apply to HMRC?

Apply using HMRC’s online service for partial exemption special methods. If you cannot use it, write to the VAT Written Enquiries team. Email applications stopped on 1 August 2022. The online service asks for a proposal document, a worked example, your latest annual adjustment calculation, your declaration and any further documents. HMRC says it will contact you within 30 days to accept the proposal, ask for more information or explain why it is unsuitable.

Appendix 2 of Notice 706 lists what HMRC normally asks for. The most important items are:

why the standard method, or your current special method, fails for your business;
other methods you considered and why you rejected them;
the difference in recovery percentage between your current method and the proposed one over your two most recent tax years;
planned capital expenditure in the next 12 months and how the method treats it, and any planned acquisitions, disposals or new activities;
your main supplies with their VAT liability and value, your main VAT bearing costs and your total residual input tax for the latest year;
a worked example using actual figures for the last tax year, last year’s partial exemption calculation and your latest annual accounts;
clear definitions of any terms, such as what counts as a transaction, or floor plans marked with taxable and exempt areas.

VAT groups need to add a group structure and details of members joining or leaving. Our guide to VAT group registration covers how groups work. You should also think about how the method treats items in the capital goods scheme.

What does the fair and reasonable declaration say?

Since 1 April 2007, regulation 102(9) has prevented HMRC approving a special method unless the business declares that, to the best of its knowledge and belief, the method fairly and reasonably represents the extent to which goods and services are used, or will be used, in making taxable supplies. Regulation 102(10) requires the declaration to be in writing, signed by the taxable person or someone authorised to sign for it, and to include a statement that the signatory has taken reasonable steps to make sure they have all the relevant information. Appendix 1 of Notice 706 gives a template.

PE43200 says a declaration is needed for every new method and every amendment, because an amended method is a new method. It covers the whole method and the whole VAT registration. The business decides who signs: a large company might authorise its VAT or tax manager, while in a smaller business a director or partner would usually sign. A business can delegate signing to an adviser, but it remains responsible for the declaration being correct.

What happens if the declaration turns out to be wrong?

Under regulation 102(11) a declaration is incorrect if the method does not fairly and reasonably reflect use and the signatory knew, or ought reasonably to have known, this when signing. HMRC can only act if the overall result is an over deduction of input tax (regulation 102(12)). It can then serve a notice that overrides the method from its effective date, not just from when the problem arose, and assess earlier periods to best judgement.

PE43300 adds that the four year cap still applies, interest and penalties may follow, and a business that discloses an incorrect declaration voluntarily avoids penalties, although interest may still be due.

When does an approved method start and how long does it last?

A new method usually applies from the start of the tax year in which HMRC received the declaration with the application that it approves (Notice 706, paragraph 6.2). PE46500 says retrospective changes beyond that are allowed only in exceptional cases, such as HMRC error, a method that cannot be operated, or a calculation that produces no result. Under PE47000, HMRC may backdate approval where a business did not realise it was partly exempt and had never used any method.

HMRC sends the approved method in a standard format, and if you do not raise concerns within 30 days it assumes you agree. The method then binds both sides until HMRC approves or directs a change (regulation 102(3)). You must still do an annual adjustment, tell HMRC promptly about changes that could significantly affect recovery, and recover any input tax the method does not cover (a gap) on the basis of use (regulation 102(6)). Either side can serve a special method override notice if the method stops being fair before a replacement is agreed.

What might a special method look like?

Illustration only. A firm earns £300,000 of taxable fees that take most of its staff time and £700,000 of exempt commission that needs little work. The standard method gives 30% recovery on £40,000 of residual input tax, or £12,000. Timesheets show 70% of staff time is spent on the taxable work, and the firm’s overheads are mainly office and staff costs. A staff time method would recover £28,000. Residual input tax is under £50,000, so the override cannot correct this. The firm proposes a staff time method, supported by two years of timesheet data, a comparison with the standard method and a signed declaration. A holding company or group with mixed activities would more likely need a sectorised method.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

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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.