If a firm retains any of the interest earned on general client account (ie not all the money is paid out to clients), then traditionally such excess interest was treated as ‘exempt’. That would necessitate a ‘partial exemption calculation’, which can then lead to an irrecoverable VAT situation where not all of the input VAT incurred by the firm on expenditure can be recovered. However, it seems that the correct approach is now to regard such income as ‘incidental supplies’ which should therefore be excluded from the calculation of irrecoverable input VAT in partial exemption calculations. The end result for many firms will be a VAT refund.

It follows that firms need to review the VAT treatment of interest income and see whether there is a partial exemption issue. Note that there is a three-year cap on recovery of VAT so it is important not to delay. For the authorities see [2008] LSG 11 September 13.© Practical Lawyer