The default position for determining how much VAT is deductible on costs is a two-step process. The first step is explained in ‘Welfare at below cost‘ and requires a charity to select its own “fair and reasonable” business/non-business (BNB) calculation. The second step is a partial exemption as calculated here.

From 1 January 2011, HMRC can approve one single agreement covering the business’s BNB and partial exemption calculations, known as the “combined method”.

The combined method operates as a special method so it is necessary for a charity to declare that the proposed combined method is fair and reasonable before HMRC can consider giving approval. Partial exemption de minimis rules do not apply if a combined method is used.

Note that from 1 January 2011 HMRC will no longer approve separate BNB and partial exemption methods; so if a charity is seeking assurance in respect of a new method it would need to be a combined method. If the charity does not have VAT on costs relating to exempt supplies it will still be able to seek approval for a BNB method.

Current agreements remain valid; but Charitable organisations should seek approval for a combined method when next routinely updating existing business/non-business and partial exemption agreements.

For further information see Chapter 7 of HMRC’s VAT Notice 706: Partial Exemption.