What is a partial exemption method in VAT?

The partial exemption method in VAT is an approach that enables businesses to reclaim some of the VAT they have incurred on purchases that are related to exempt supplies. In practice, certain businesses make both taxable and exempt supplies. Since they are not allowed to reclaim VAT fully on purchases related to exempt supplies, the partial exemption method provides a way to determine how much VAT can actually be reclaimed based on the proportion of taxable versus exempt activities the business engages in.

For example, if a company engages in both exempt and taxable sales, it needs to calculate the ratio of its taxable sales to its total sales to establish the allowable proportion of VAT it can claim back on its inputs. This method acknowledges that while some supplies may be exempt from VAT, businesses often still incur VAT on related costs, and provides a systematic way to reclaim a portion of that VAT consistent with their economic activity.

In contrast, other methods mentioned either suggest complete avoidance of VAT payments on purchases, which is not how VAT operates, or inaccurately relate the method to company size or restrictions specific to financial services. This highlights how the partial exemption method serves a specific purpose in ensuring fairness and balance in VAT reclamation for mixed supply businesses.