ACCA Advanced Taxation (ATX) Practice Exam

What are the potential implications if a business fails either simplified Test 1 or Test 2 for VAT partial exemption?

1. The business must pay a penalty fee

2. The business cannot recover any input VAT

3. The business has to lower its VAT rate

4. The business will face an audit

The correct answer is: The business cannot recover any input VAT

If a business fails either simplified Test 1 or Test 2 for VAT partial exemption, it directly affects the business's ability to recover input VAT. Under VAT law, partial exemption rules apply to businesses that carry out both taxable and exempt supplies. When a business fails to satisfy the conditions laid out in these tests, it indicates that the proportion of exempt supplies is significant enough that the business can no longer recover input VAT proportionally to its exempt activities. In practice, this means that the business is essentially not allowed to reclaim any VAT on purchases that relate to making exempt supplies. This is pivotal because input VAT recovery is a key benefit of being VAT registered, allowing businesses to lower their overall tax burden. Therefore, failing these tests can have a substantial financial impact as businesses will have to absorb the VAT costs associated with their exempt supplies rather than reclaiming them from the tax authorities. The other options listed involve scenarios that are not typical consequences of failing these VAT tests. While fines and audits can occur under different circumstances, they are not automatic outcomes tied specifically to the failure of these tests. Lowering a VAT rate is not a requirement triggered by failing the tests either, as rates are governed by fixed rules and not performance in these tests.