Even the best laid plans are liable to change. The 'payback and clawback rules' for VAT reflect this reality. These rules only relate to input issues and apply to situations where VAT has been claimed, refunded or recovered, and HMRC either requires repayment or adjusts future claims.

The ‘payback’ rules apply when intended exempt or partially exempt sales are superseded by taxable sales, allowing input tax that was previously not claimed to be included in the next VAT return.

For example, if a VAT-registered business purchases office equipment for £1,200 (including VAT), intending to use it 50% for business and 50% for personal use, it can reclaim £100 of VAT. If the business later changes its use of the equipment to 70% for business purposes, it can reclaim an additional £40 of input tax – this extra £40 is termed ‘payback’ under the VAT adjustment rules.

The 'clawback' rules deal with the opposite situation, typically referring to VAT claimed on construction projects where a developer builds a house with a view to selling. VAT input tax is claimed on the project costs because the sale is zero-rated.

However, if something happens to change their mind and the developer decides to rent out the property long-term instead, the income generated will be exempt from VAT. HMRC will require the developer to repay the VAT that was initially claimed ('clawback'). The repayment is payable because the input tax originally claimed was based on the intended taxable use; since the actual activity now generates exempt income, the developer must repay the input tax on the return that aligns with the change in intention. A clawback adjustment is a one-off event and the developer would only make a second adjustment if the building is never rented out.

Another, although less common, variation involves a mixed-use outcome. In this situation there is a change of intention from generating either wholly taxable or wholly exempt income to a mixture of both (so the input tax either starts or finishes as ‘residual input tax’ in terms of partial exemption). Residual input tax is input tax on purchases used to make both taxable and exempt supplies.

Temporary change

If the intended supply is VAT claimable and the change of intention is temporary, only a proportion of the VAT needs to be repaid. Adjustments can be made based on a ten-year life span of the property. Additionally, no clawback is required if the repayable amount averages less than £625 a month and does not exceed 50% of the total input VAT.

A typical example

Intention is the most important point to consider. A typical example of this principle can be seen in the tax case of Briararch Ltd and Curtis Henderson Ltd [1992] STC 732. The business built a property intending to grant a zero-rated major interest (an outright sale of the freehold) and correctly attributed input tax to this intended taxable supply, recovering in full. However, due to a collapse in the property market, they were unable to sell and had to let it.

HMRC sought to recover the full input VAT under the 'clawback' provisions since the intended taxable supply was replaced by an exempt supply. However, the High Court judges ruled that, because the business still had an underlying intention to make a taxable supply, only a proportion of the VAT could be recovered, taking into account potential future supplies.

Practical point

Should the change of intention occur after the year end but within six years of the tax quarter in which the input tax deduction is made, the input tax is repaid in the quarter during which the change of intention takes place. The original deduction remains unchanged since the attribution was correct at the time of claim.