There has been some speculation in the professional services world that HMRC will look at whether input tax should be apportioned under partial exemption where professional services firms earn interest on the sums held in client accounts.
In the past, HMRC has treated the interest as “incidental” to any supply on the basis that it is passively earned. However, with the increased interest rates, the amounts earned on client account monies is becoming larger and we have heard of HMRC claiming that the quantum means that the interest income is no longer incidental but is an exempt supply, leading to potential disallowance of input tax under the partial exemption rules.
Case law does not support this and neither does HMRC’s own internal guidance. If there are no resources allocated to actively managing the interest income (e.g. continuously moving monies to achieve the best interest rate), the interest is still passively earned, despite the quantum. However, if the amount a large proportion of your income (e.g. 20-30%), it does suggest that there is some degree of management beyond the typical interest rate that can be obtained from a bank.
Please do not hesitate to contact us if you would like some advice on whether your client account might cause you issues from a VAT recovery perspective.
