Insurance VAT Recovery & Partial Exemption

Insurance VAT recovery is rarely determined by a single percentage. For insurers, brokers and wider insurance groups, the final position depends on what each business supplies, where customers and insured parties are based, how costs are incurred and whether the group structure reflects commercial reality.

When those factors are not reviewed together, Value Added Tax (VAT) can become embedded in technology, property, professional fees and outsourced services without the business recognising why. The result may be unnecessary cost, an overstated VAT claim or a partial exemption method that no longer matches the business.

A useful review starts with a practical question: where is VAT being incurred, and which activities do those costs actually support?

Exempt premiums are only part of the picture

The supply of insurance is generally exempt from VAT. That distinction matters: an exempt supply is different from a zero-rated supply because it does not normally give the insurer a right to recover the VAT on directly related costs.

Life, motor and property insurance premiums will commonly be exempt, as will reinsurance and qualifying brokerage or intermediary services. Certain claims-handling and policy-administration activities can also fall within the exemption, but only where their nature and the supplier’s role meet the relevant conditions.

Other work performed by the same group may be taxable. Examples include risk consultancy, data analysis, software licensing, separately supplied back-office support and management services charged to a customer outside the VAT group. A commercial property letting may also be taxable where a valid option to tax applies.

The correct answer depends on what is actually supplied. Treating all claims-related services as exempt, or all outsourced administration as taxable, can produce the wrong result.

Follow the revenue before reviewing the VAT

An insurance group should map its income before testing the amount of VAT it can claim. The categories to separate include:

Exempt insurance, reinsurance and qualifying intermediary income
Taxable consultancy, management, technology and commercial property income
Overseas services that would be taxable if supplied in the UK
Qualifying insurance or intermediary supplies carrying deduction rights under the specified supplies rules
Dividend income and other amounts that are outside the scope of VAT
Transactions disregarded because they take place between UK VAT-group members

These categories do not all belong in the same part of the partial exemption calculation. Classifying an overseas transaction or internal recharge incorrectly can affect the recovery percentage before any individual purchase invoice is considered.

Start with costs, not just percentages

Partial exemption applies where a VAT-registered business incurs costs used for both supplies carrying a right to deduct and exempt supplies without that right. The calculation begins with attribution rather than simply applying one recovery rate to every invoice.

VAT on a cost used solely for taxable consultancy or a qualifying overseas supply may be recoverable in full. VAT on a cost used solely for exempt UK insurance business will usually be blocked. Costs supporting both activities, such as premises, finance systems, audit work and general legal advice, are residual and require apportionment.

This makes coding, invoice descriptions and cost-centre ownership important. If expenditure that should be directly attributed is left in the overhead pool, the business may either lose a legitimate VAT claim or recover too much. An annual adjustment is also needed to reconcile the position across the VAT year.

Why turnover can misrepresent an insurer’s cost use

The standard partial exemption method broadly measures deductible turnover against total relevant turnover. That may work for a relatively simple business, but premium income can dominate an insurer’s figures without showing how the business actually uses its people, systems or property.

A taxable advisory or technology function might use a substantial share of group resources while generating far less turnover than the insurer’s premium book. A pure turnover calculation could therefore restrict VAT recovery beyond what the economic use of those overheads justifies.

When the standard method must be challenged

A standard method override can be required where the normal calculation produces a result that is not fair and reasonable. It is generally considered where annual residual input VAT exceeds £50,000; for some related undertakings outside the same VAT group, the relevant threshold is £25,000.

The difference must also be substantial. In broad terms, this means an amount exceeding £50,000, or an amount exceeding 50% of residual input VAT and amounting to at least £25,000. The comparison is made against a method that better reflects the actual use of the relevant costs.

Repeated override calculations may be a sign that the business needs more than a year-end correction. It may need an agreed method designed around the insurance operation itself.

Build a special method around the business

A Partial Exemption Special Method (PESM) can replace the standard turnover calculation where another basis provides a fairer view of how residual expenditure is used. HM Revenue & Customs (HMRC) has published an insurance-sector framework to help businesses develop appropriate approaches.

Depending on the organisation, a suitable method could use:

Time spent by teams on exempt and deductible activities
Employee numbers or salary expenditure by business function
Property occupation or floor-space allocations
Policy, claim or transaction volumes where these reflect cost use
Accounting allocations or other reliable operational data
Separate calculations for distinct parts of a diversified group

A special method needs written HMRC approval before it is used or changed. The business must be able to explain why the method is fair, operate it consistently and revisit it when acquisitions, reorganisations or new product lines change the underlying facts.

Overseas insurance income: check the customer and the insured

International activity can increase input VAT recovery, but only when the relevant deduction conditions are satisfied. A consultancy service supplied outside the UK may carry a deduction right if it would have been taxable had it been supplied here. Certain otherwise exempt insurance, reinsurance and intermediary services can also qualify under the specified supplies rules.

The analysis does not stop with the address on the invoice. The business needs to identify the actual service, the contractual recipient, the place of supply and, where relevant, the location of the insured party. For insurance intermediary services from 1 January 2024, the position turns on whether the final consumer or insured belongs outside the UK.

A foreign customer does not automatically make a transaction deductible. Equally, treating all non-UK insurance income as ordinary exempt turnover may leave valuable recovery unclaimed.

An opportunity to revisit pre-2024 intermediary claims

HMRC has clarified that some insurance intermediaries can reconsider earlier VAT periods where they supplied qualifying services to a customer outside the UK. For accounting periods ending on or before 31 December 2023, recovery may be available even if the insured person was UK-based.

The normal four-year statutory limit still applies, so older periods will fall out of time. Any claim should be supported by the commercial agreements, evidence of the customer’s location and an updated partial exemption calculation. The rules applicable from 1 January 2024 are different and should not be applied retrospectively to qualifying historic periods.

VAT grouping can remove one cost while leaving another

A UK VAT group generally treats transactions between its members as disregarded for VAT purposes. This can remove VAT from internal management or administrative recharges that might otherwise create an irrecoverable cost for an exempt insurer.

However, VAT grouping is not the same as full VAT recovery. The VAT group’s external supplies determine its overall recovery position, and VAT charged by third-party suppliers remains subject to the appropriate direct attribution and partial exemption treatment.

A group change can also affect an agreed special method, existing Capital Goods Scheme calculations and the treatment of international establishments. Membership decisions should therefore be assessed before a company joins or leaves, rather than after the next VAT return has been prepared.

Shared-service companies need their own review

Centralised companies often handle finance, compliance, procurement, technology and payroll for several group businesses. If the service company sits outside the VAT group, its charges to an insurer may attract VAT that cannot be reclaimed in full.

Bringing that company into the VAT group may remove VAT on the internal recharge, but it also brings the company’s third-party expenditure into the group’s wider recovery calculation. The right structure depends on who receives the underlying supplies, which external activities benefit and whether any cross-border services trigger a separate VAT charge.

Holding companies: activity matters more than ownership

Merely owning shares in subsidiaries and receiving dividends does not normally amount to an economic activity for VAT purposes. A passive insurance holding company will therefore struggle to recover VAT on costs linked solely to that ownership.

The position may improve where the company genuinely supplies management or other taxable services for payment. But contracts alone are not enough: the holding company must receive the relevant third-party supplies and demonstrate how the expenditure supports an actual economic activity. VAT grouping and partial exemption can still restrict the result.

Overseas purchases and hidden reverse-charge costs

Software subscriptions, specialist advice, overseas support functions and cross-border group services can all create a UK reverse-charge obligation. The UK business may need to account for output VAT on the imported service, even when the overseas supplier does not add VAT to its invoice.

A fully taxable business may offset the corresponding input VAT. An insurance group with restricted recovery cannot always do so, meaning part of the reverse charge becomes a real cost. Intercompany cost allocations can be particularly easy to miss where they are recorded in the accounts without a conventional supplier invoice.

Capital assets: the rules changed in July 2026

The Capital Goods Scheme (CGS) adjusts VAT recovery on certain high-value assets as their use changes over time. Qualifying land and buildings can remain within the scheme for up to ten years, so a new partial exemption percentage, reorganisation or change in VAT-group membership can affect earlier VAT recovery.

For relevant property expenditure from 29 July 2026, the VAT-exclusive threshold for qualifying land, buildings and civil engineering works is generally £600,000. Earlier qualifying property expenditure was generally assessed against a £250,000 threshold.

Computers and computer equipment acquired from 29 July 2026 are no longer brought into the scheme. Existing assets already caught under the previous rules continue through their original adjustment periods, so the historic asset register still matters. Technology, software and data-centre projects need to be analysed according to what is actually being acquired: a qualifying property fit-out is not the same as a software licence.

What an effective insurance VAT review should cover

A focused review should connect the group’s commercial activities, accounting data and VAT calculations. The priority questions include:

Are insurance, brokerage, claims-handling and support services classified correctly?
Have deductible overseas supplies been separated from ordinary exempt income?
Can the business evidence customer location and, where needed, the location of the insured?
Are costs directly attributed before the residual recovery percentage is applied?
Does the standard method fairly reflect cost use, or is an override or approved special method needed?
Do VAT-group membership and shared-service arrangements still support the intended outcome?
Are overseas supplier invoices and intercompany allocations triggering reverse-charge VAT?
Are capital assets recorded under the right pre- or post-July 2026 rules?
Could pre-2024 intermediary income support a time-sensitive historic claim?

The aim is not simply to increase a recovery percentage. It is to reach a result that is accurate, commercially sensible, properly evidenced and capable of standing up to HMRC scrutiny.

How The VAT Consultancy can help

The VAT Consultancy’s insurance-sector VAT specialists advise insurers, brokers, reinsurers, claims handlers and intermediaries on VAT liability, partial exemption, specified supplies, group structures and historic recovery opportunities. We can review your existing method, identify where VAT is being trapped and support discussions with HMRC where a revised approach is appropriate.

Our VAT risk management and control team can also help strengthen your processes, while our VAT cost-reduction specialists can assess whether recoverable VAT has been overlooked. To arrange an insurance VAT recovery review, contact The VAT Consultancy.

Insurance VAT recovery: where avoidable costs build up