On our recent call with HMRC, we discussed Capital Sectors in Partial Exemption Special Methods (PESM) and HMRC has issued the attached note to try to help to clarify some of the issues. It is important that you refer to this if you are intending to negotiate a new method or are revising a current method.
In summary:
In setting up a Capital Sector in a PESM there are two options:
- sector specifically about a project – if it requires amending the total PESM will have to be reviewed by HMRC; or
- a flexible sector covering projects over a financial limit (e.g., net value or VAT incurred on a project). Use can be agreed on a project-by-project basis.
HMRC's suggestion is to use Option 2 - as it does not lead to a review of the total PESM.
Issues being noted:
- A capital project covered by the sector should be defined. HMRC gave the example of a 3-storey building with redevelopment of each floor being a separate project costing £2m – that could be 3 x £2m projects or 1 x £6m project. Suggestions of how to define this are in the note
- In some applications, the capital sector is determined by a financial limit plus if taxable use is over x% - this can cause confusion and uncertainty, as HMRC need to agree “use”
- Use should be agreed provisionally with HMRC as early as possible in a project – HMRC confirmed that if necessary, it can then be revised at a later date, e.g., as a building goes into use
- The financial limit of the capital sector can be revised without reviewing the whole method – but you cannot cherry pick which limits apply to which projects
HMRC confirmed that:
- even if the intention is to use the general overhead percentage for a particular project this still needs to be agreed with HMRC
- any use based apportionment % agreed for the capital sector could also be applied to revenue costs, such as utility bills.
If members have any questions or comments about this briefing note, please contact Andrea and she will pass them onto HMRC.
20 July 2021 
Andrea Marshall, Tax Specialist
