Care Agency VAT: What Partial Exemption Costs You When Taxable Income Creeps In

The short answer: are you still VAT exempt?

Your core care work is still exempt, and the taxable income sitting next to it is what changes everything. Welfare services supplied by a state-regulated home care agency to the person receiving the care are exempt from VAT under Group 7 of Schedule 9 to the VAT Act 1994, even when a local authority or a direct payment foots the bill. That has not changed. What changes is that once you also make taxable supplies, you stop being a wholly exempt business and become a partially exempt one, and partial exemption decides how much of your input VAT you are allowed to claim back.

Most owners find this out the hard way. You have run the agency for years, never charged VAT, never reclaimed any, and never needed to. Then you win a contract supplying carers to a neighbouring provider, or start running paid training for other people's staff, and suddenly you have taxable income. HMRC's welfare guidance is clear that a state-regulated domiciliary care agency supplying care to the final consumer is making an exempt supply, and its Welfare services and goods notice (VAT Notice 701/2) confirms this even where a council contracts and pays for the care. The taxable side is a separate world with separate rules.

This is a specialist corner of VAT, and getting it wrong is expensive in both directions: claim too much and you face an assessment plus interest, claim too little and you leave real money with HMRC every quarter. If you want the wider picture on structuring a home care business for tax, payroll and compliance, our page for care agency accountants sets out how the whole thing fits together. This article is about one specific mechanic: what partial exemption does to your VAT once taxable income creeps in.

What counts as taxable income for a care agency

Taxable income is anything you supply that is not exempt welfare care, and for a home care agency there are four usual suspects. The line matters because only taxable supplies carry the right to recover input VAT, and only taxable turnover counts towards registration. Here is what typically sits on the taxable side of the fence:

• Staff supply to other providers. When you supply carers or nurses to another business that is legally responsible for the onward care, you are making a taxable supply of staff, not exempt welfare care. HMRC spells this out in its welfare manual on supplies of staff (VATWELF5000): an employment business in the welfare sector makes a taxable supply of staff where the third party carries the legal responsibility for providing care to the final recipient.
• Training courses. Running paid moving-and-handling, medication or care-certificate training for other agencies' staff is a commercial supply of training, standard rated unless a specific education exemption applies (it rarely does for a care agency).
• Equipment and consumable sales. Selling PPE, hoists, mobility aids or consumables to other providers or to private clients is a standard-rated sale of goods.
• Introductory and agency commissions. If you charge a fee for arranging and administering a supply rather than providing the care yourself, that commission is standard rated, as the welfare manual notes for agents.

Everything else you do for the people you actually care for, the council-commissioned home visits, the private-pay domiciliary care, the care funded through a direct payment, stays exempt. So a typical agency ends up with a big exempt block and a smaller taxable block sitting beside it. That mix is the trigger. One kind of income on its own is simple; the two together are what create partial exemption, which is why specialist care agency accounting keeps the exempt and taxable ledgers as two separate streams from day one.

How partial exemption actually works

Partial exemption works by sorting every pound of input VAT you incur into three buckets, then deciding which buckets you are allowed to recover. Input VAT is the VAT you pay on your own costs: software, rent, PPE, accountancy, phones and so on. The Partial exemption notice (VAT Notice 706) sets out the standard method every smaller business uses, and it runs in three steps.

First, directly attributable to taxable supplies. This is input VAT on costs used only to make your taxable supplies: the venue and materials for a training course you sell, stock you buy in to resell, advertising for the staff-supply arm. You recover this in full.

Second, directly attributable to exempt welfare care. This is input VAT on costs used only for the exempt care: the per-carer licences on your care-planning software, PPE and uniforms for care visits, DBS checks on care staff. You cannot recover any of this. It is a real cost that stays with the business.

Third, residual input VAT. This is the overhead VAT on costs used for both sides of the business at once: the office rent, the accountancy fee, the phone system, head-office IT. You recover a share of it, and the share is set by the standard method calculation: the value of your taxable supplies divided by the value of all your supplies, multiplied by 100, rounded up to the next whole percentage. Apply that percentage to your residual VAT and that is the recoverable slice; the rest is blocked. Our VAT returns and Making Tax Digital service runs this split every quarter so the recoverable figure is never guessed.

The Venn below shows why the two blocks of income together, not either one alone, are what make you partially exempt.

The de minimis test, and when you can still recover everything

There is a relief valve, and it is called de minimis: if your blocked exempt input VAT is small enough, you get to recover it anyway. HMRC's partial exemption guidance in manual PE24500 on de minimis sets the limit under Regulation 106 of the VAT Regulations 1995. As at September 2026, you are de minimis, and can recover all your input VAT for the period, only if both of these are true:

• your exempt input tax is no more than £625 per month on average (so no more than £7,500 across a full VAT year); and
• your exempt input tax is no more than 50 percent of your total input tax.

It is an all-or-nothing test, not an allowance. Pass both limbs and every pound of input VAT comes back, including the exempt slice. Fail either limb and the exempt input VAT is blocked in full, with nothing recoverable on that side beyond the directly attributable taxable VAT and the recoverable residual slice. You test it in each VAT period and again across the longer period, usually your partial exemption tax year, through an annual adjustment.

For a small agency dipping a toe into taxable work, de minimis can genuinely keep the whole thing tidy for a year or two. The problem is scale. A busy London home care agency with 15 or more carers spends real money on care-planning software, PPE and rostering, and once the exempt-attributable and exempt-residual VAT stack up past £625 a month, the relief valve closes. That is exactly where the worked model below lands.

A full worked model: £480k exempt, £120k taxable

Here is the whole thing worked end to end, with numbers you can map onto your own agency. Take a London home care agency turning over £600,000 a year. Of that, £480,000 is exempt welfare care (council-commissioned home care, private-pay visits and direct payment care) and £120,000 is taxable income: £72,000 of staff supply to other providers, £30,000 of paid training and £18,000 of equipment sales. Taxable supplies are 20 percent of total supplies (£120,000 divided by £600,000), and that 20 percent is the recovery percentage the standard method will use on the residual VAT.

Now the input VAT. Say the agency incurs £18,000 of input VAT across the year. After direct attribution it breaks down like this:

• Directly attributable to taxable supplies: £3,200. Training venue and materials, stock bought to resell, advertising for the staff-supply arm. Fully recoverable.
• Directly attributable to exempt welfare care: £8,800. Per-carer care-planning software, PPE and uniforms for care visits, DBS checks. Blocked.
• Residual overhead VAT: £6,000. Office rent, accountancy, phones, head-office IT, used by both sides. Apportioned.

The standard method recovers 20 percent of the £6,000 residual, which is £1,200, and blocks the other £4,800. So the agency recovers £3,200 plus £1,200, a total of £4,400, and blocks £8,800 plus £4,800, a total of £13,600. The donut shows how the £18,000 splits before the residual is apportioned.

Then comes the de minimis check on that £13,600 of blocked exempt input tax. Averaged over the year it is about £1,133 a month, comfortably over the £625 limit, and the exempt supplies are 80 percent of turnover, well over the 50 percent limb. The agency fails both limbs, so the £13,600 is genuinely irrecoverable. That is roughly 2.3 percent of turnover leaking straight out as a cost that never appears on a purchase invoice. For an agency running on the tight margins domiciliary care is known for, that is the difference between a viable contract and a loss-making one, which is why we build it into pricing from day one.

The £90,000 trap: how taxable income drags you into registration

The registration threshold is measured on taxable turnover only, and that is where a lot of exempt agencies get caught out. Since 1 April 2024 the VAT registration threshold has been £90,000 of taxable turnover in any rolling twelve months, as HMRC confirms in its guidance on the increased VAT registration threshold. Crucially, your exempt welfare care does not count towards that figure. Only the taxable side does.

Work through what that means for the agency in the model. Its exempt care is £480,000, but exempt income is ignored for registration, so on that alone it would never need to register. The taxable income is £120,000, and because that is above £90,000, the agency must register for VAT, back-dated to when it crossed the line. Owners routinely misread this. They see £480,000 of exempt turnover and assume they are safe, or they see £600,000 total and panic that all of it is now taxable. Both are wrong. Registration is triggered by the £120,000 taxable slice, and once you register, VAT only ever applies to the taxable supplies, never to the exempt care.

The trap is the timing. Because staff-supply and training income can grow quickly, an agency can cross £90,000 of taxable turnover mid-year without noticing, then face a late-registration penalty and a bill for VAT it should have charged its business customers but did not. Watching the rolling taxable figure, not the headline turnover, is the whole game. This is one reason a care-sector specialist earns their fee: the exempt-versus-taxable split has to be tracked every month, not reconstructed in a panic at the year end.

What this means for you: what to do before your next VAT return

Get the split right before you file, not after HMRC asks. The actions here are practical and most of them are quick, but they need doing in the right order:

1. Separate your income now. Split your sales ledger into exempt welfare care and taxable supplies (staff supply, training, equipment, commissions). If you can't see the two blocks at a glance, you can't run partial exemption at all.
2. Watch the rolling taxable figure. Track taxable turnover over each rolling twelve months against £90,000. Exempt care is ignored, so only the taxable slice counts. Diarise a check every month, not every year.
3. Direct-attribute your costs. Tag each VATable cost as taxable-only, exempt-only or shared. The cleaner the tagging, the smaller the residual pot you have to apportion and the more defensible the claim.
4. Run the standard method and the de minimis test every period. Recover the taxable-attributable VAT in full, apply the taxable-to-total percentage to the residual, then test whether the blocked exempt VAT is under £625 a month and under half your input tax.
5. Do the annual adjustment. The quarter figures are provisional. The longer-period calculation at the year end trues them up, and skipping it is the most common partial-exemption error we correct on takeover.
6. Price the blocked VAT into your taxable work. If £13,600 of input VAT is genuinely irrecoverable, that is a cost of running the taxable side. Build it into your staff-supply and training rates rather than absorbing it silently.

None of this is exotic. It is bookkeeping discipline plus one quarterly calculation, done in the right sequence. Left to chance it turns into an assessment, a penalty, or years of over-claimed or under-claimed VAT that all has to be unpicked at once.

LOYALS runs the weekly payroll, the council and private invoicing and the quarterly VAT return for home care agencies across London and the UK, so the exempt and taxable split is calculated the same way every period and the recoverable slice is never left on the table.

If you'd rather hand the whole thing over, this is core work for specialist care agency accountants: our Care Payroll and Compliance service starts at £995 a month and the Care Finance Department, which runs your council and private invoicing, weekly credit control and quarterly VAT, is £1,495 a month.