VAT recovery for insurance groups: managing partial exemption

For insurance groups, Value Added Tax (VAT) is often more than a compliance issue. Because insurance and many related services are exempt from VAT, tax incurred on professional fees, technology, property and other business costs can become a significant expense rather than a recoverable amount.

However, exempt insurance income does not mean that all input VAT is irrecoverable. Your group may also provide taxable management, consultancy or technology services, make qualifying overseas supplies or operate a VAT group. The amount you can recover depends on how those activities are classified, how your costs are used and whether your partial exemption method reflects the way your business operates.

Why is VAT recovery difficult for insurance groups?

Unlike most commercial businesses, an insurer commonly generates much of its income from VAT-exempt supplies. Insurance premiums are not zero-rated: they are generally exempt, which means input VAT directly attributable to that income will not normally be recoverable.

At the same time, an insurance group may have several companies, international operations, shared-service arrangements and other income streams that carry a right to deduct VAT. This combination makes accurate VAT recovery essential. Even a modest change in your recovery percentage can have a material effect when applied across a large cost base.

Which insurance activities are exempt or taxable?

The first step is to identify the correct VAT treatment of each income stream. Activities that are commonly exempt include:

• Insurance premiums, including life, motor and property insurance
• Reinsurance contracts between insurers
• Qualifying insurance brokerage and intermediary services
• Claims handling or policy administration where the relevant insurance exemption applies
• Exempt property income, including rent where there is no effective option to tax

Other activities may be taxable or otherwise carry a right to deduct input VAT, depending on their contractual terms and the underlying facts. These can include:

• Management or shared services supplied to third parties or companies outside your VAT group
• Consultancy, risk management and data analytics services
• Software licensing and other technology services
• Standalone administration, technical or underwriting support that does not qualify for the insurance exemption
• Commercial property income where a valid option to tax applies
• Qualifying overseas insurance, intermediary or other international service income

Some receipts, such as dividends, may be outside the scope of VAT. Supplies between members of the same UK VAT group are also generally disregarded. These categories need to be identified separately rather than automatically treated as taxable income.

How does partial exemption affect insurance VAT recovery?

A VAT-registered business is partially exempt when it incurs VAT on costs used to make both taxable and exempt supplies. The basic principles are:

• Input VAT directly attributable to taxable supplies, or other qualifying supplies that carry a right to deduct, is normally recoverable
• Input VAT directly attributable to exempt supplies without a right to deduct is normally irrecoverable
• Input VAT on overheads supporting both activities must be apportioned using a fair and reasonable method

The default approach is the standard method, which broadly apportions residual input VAT by reference to supplies carrying a right to deduct as a proportion of total relevant turnover. Calculations are generally completed during the year and reviewed through an annual adjustment.

For insurance groups, the standard method can produce a distorted result because insurance premium income may be high compared with the value of other services, even where those services use a meaningful proportion of shared costs. A turnover-based calculation may therefore fail to reflect how your business actually uses its expenditure.

Can overseas insurance income improve VAT recovery?

International income can affect your partial exemption calculation, but not every overseas transaction carries a right to deduct. Two categories need to be considered separately.

The first is a service supplied outside the UK that would have been taxable if supplied in the UK. The second is a qualifying insurance, financial or intermediary supply covered by the specified supplies rules. These are otherwise exempt transactions for which UK law can nevertheless permit input VAT recovery.

Depending on the circumstances, qualifying income may include insurance or reinsurance provided to an overseas customer and certain intermediary commissions connected with an insured person outside the UK. Since 1 January 2024, the position for insurance intermediaries has depended on where the final consumer or insured party belongs, rather than simply the location of the intermediary’s immediate customer.

To support your recovery, you should review the nature of each service, the applicable place-of-supply rules, the location of the customer and insured party, and the evidence available. Correctly identifying qualifying overseas income can materially improve VAT recovery, but applying the wrong treatment can create an exposure to HM Revenue & Customs (HMRC).

How do direct attribution and residual input VAT work?

Before applying a recovery percentage, you should directly attribute costs where they are used exclusively for a particular type of supply. For example, a professional fee incurred solely to support exempt insurance activity will usually be irrecoverable. By contrast, a cost directly connected with taxable consultancy or a qualifying overseas supply may be recoverable.

The remaining input VAT is residual. It may arise on offices, technology, audit fees, legal advice, procurement and other overheads used across the business. This residual amount is then apportioned under the standard method or an approved special method.

Accurate cost coding and supporting evidence are important. If a directly attributable cost is incorrectly included in the residual pool, or if business changes are not reflected in your calculations, the resulting recovery can be overstated or understated.

When does the standard method override apply?

Where the standard method does not fairly reflect how residual costs are used, an annual standard method override may be required. This generally becomes relevant where annual residual input VAT exceeds £50,000, although a £25,000 threshold can apply to certain related undertakings that are not in the same VAT group.

An adjustment is required where the difference between the standard method and a fair-and-reasonable calculation is substantial. Broadly, this means that the difference exceeds £50,000, or exceeds 50% of the residual input VAT and is at least £25,000.

An override does not replace the longer-term need to review whether your recovery method remains suitable. Where the standard method repeatedly produces an unfair outcome, an approved special method may be a more appropriate solution.

Why can a partial exemption special method be more suitable?

A Partial Exemption Special Method (PESM) is an alternative approach agreed with HMRC to produce a fairer and more reasonable allocation of residual input VAT. HMRC has also published an insurance-sector partial exemption framework, developed with the Association of British Insurers, which can help businesses structure an appropriate method.

An insurance group’s special method may divide the business into sectors and use measures that better reflect the economic use of costs, including:

• Headcount or time spent on different activities
• Salary costs associated with particular business functions
• Floor space occupied by different teams or operations
• Transaction volumes or other operational measures
• Cost allocations and accounting data
• A combination of measures across different sectors of the group

You need HMRC’s written approval before introducing or changing a special method. The proposal should explain why it provides a fair and reasonable result and show that it can be operated consistently. An existing method should also be reviewed when acquisitions, reorganisations, new products or changes in group membership alter the way costs are used.

How do VAT groups and shared-service companies affect recovery?

Companies under common control can often register as a UK VAT group. Supplies between group members are generally disregarded for VAT purposes, which can prevent an additional VAT charge on management fees, finance, technology, procurement or other shared services.

This can be particularly valuable where a central shared-service company supports an insurer whose external supplies are largely exempt. If that company is outside the VAT group, taxable recharges may generate VAT that the insurer cannot recover in full.

However, joining a VAT group does not make third-party VAT automatically recoverable. Recovery is determined by the group’s external activities as a whole, and the shared-service company’s costs form part of the group’s overall calculation. Adding or removing a company can therefore change your recovery position, special method and Capital Goods Scheme adjustments. Cross-border establishments can also create exceptions that need separate consideration.

Can insurance holding companies recover input VAT?

A holding company that only owns shares and receives dividends is not normally carrying on an economic activity for VAT purposes. VAT incurred solely in connection with that passive activity will generally not be recoverable.

The position can differ where the holding company genuinely provides management or other taxable services to its subsidiaries for consideration. However, recovery depends on the company being the recipient of the relevant supplies, having a genuine economic activity and demonstrating a link between its costs and that activity. Partial exemption and VAT grouping may also affect the final result.

What is the impact of reverse-charge VAT on overseas services?

Insurance groups often buy technology, advisory, administrative or other services from overseas suppliers. Under the reverse-charge rules, your UK business may have to account for output VAT on those purchases as though it had supplied the service to itself.

For a fully taxable business, the corresponding input VAT may be recoverable in full. For a partially exempt insurer, recovery may be restricted, leaving a genuine VAT cost. Overseas purchases and cross-border internal arrangements should therefore be reviewed alongside your wider partial exemption position.

How does the Capital Goods Scheme affect insurance groups?

The Capital Goods Scheme (CGS) can require input VAT recovery on qualifying capital expenditure to be revisited over several years. For land and buildings, the adjustment period can extend to ten years, meaning changes in taxable use, partial exemption recovery or VAT-group membership may affect the amount you ultimately retain.

The rules changed on 29 July 2026. For relevant expenditure from that date, qualifying land, buildings and civil engineering works generally enter the scheme only where VAT-exclusive expenditure reaches £600,000. The corresponding threshold for earlier qualifying property expenditure was generally £250,000.

Computers and computer equipment acquired from 29 July 2026 no longer enter the scheme. However, assets that entered the scheme under the earlier rules remain subject to their existing adjustment periods. Software, intellectual property and data-centre expenditure should not be assumed to fall within the scheme automatically: the correct treatment depends on the nature of the asset and whether qualifying property works are involved.

Maintaining an accurate capital asset register can help your group identify which assets remain within the scheme, apply the correct threshold and monitor changes that trigger annual adjustments.

Could historic insurance intermediary VAT claims be available?

HMRC has clarified its approach to certain historic insurance intermediary services supplied to customers outside the UK. For qualifying accounting periods ending on or before 31 December 2023, an intermediary may be able to revisit input VAT recovery even where the insured person was in the UK.

Any claim remains subject to the normal four-year statutory time limit and requires evidence supporting the services, the overseas customer and the revised partial exemption calculation. The position changed from 1 January 2024, when the location of the final insured party became relevant under the amended rules. If your group has historic overseas intermediary income, reviewing the position promptly may help you identify claims before relevant periods fall out of time.

What should insurance groups review?

A practical VAT recovery review should consider whether your group can:

• Identify and correctly classify exempt, taxable, outside-scope and qualifying overseas income
• Evidence the location of overseas customers and insured parties
• Directly attribute costs correctly and maintain accurate cost coding
• Test whether the standard method and any required override reflect actual economic use
• Review an approved special method against current business activities and HMRC’s insurance-sector framework
• Assess VAT-group membership, shared-service arrangements and holding company activity
• Identify reverse-charge costs and cross-border arrangements that generate irrecoverable VAT
• Apply the current Capital Goods Scheme thresholds while monitoring legacy assets already within the scheme
• Consider whether historic overseas intermediary claims remain within the statutory time limit

When your group structure, revenue streams or investment plans change, reviewing VAT recovery early can help you avoid unexpected costs and support a more defensible position with HMRC.

How Blick Rothenberg can help

Blick Rothenberg’s Indirect Tax team can help you review insurance VAT recovery, assess partial exemption calculations, identify qualifying overseas income, agree an appropriate special method and understand the impact of VAT grouping or capital expenditure. Our Financial Services specialists work with our indirect tax advisors to provide practical, commercially focused support tailored to your group’s circumstances. To discuss your position, please contact our VAT team.

Sources
HMRC: Partial exemption (VAT Notice 706)
HMRC: Insurance sector partial exemption framework
HMRC: Insurance (VAT Notice 701/36)
HMRC: Changes to the VAT Capital Goods Scheme
HMRC: VAT deduction on insurance intermediary services supplied outside the UK
HMRC: Group and divisional registration (VAT Notice 700/2)
HMRC: VAT recovery by holding companies
HMRC: VAT on services from abroad