It was announced at Budget time that the partial exemption simplification rule for VAT purposes was to be abolished.

Regulation 105 of the VAT Regulations 1995 provided that VAT input tax incurred by some businesses which was attributable to certain exempt supplies would be recoverable, because it was deemed to be attributable to taxable supplies.

Banks, insurance companies and building societies, were unable to take advantage of this rule.In terms of the solicitor who carried out investment business for clients, it was formerly the case that any input tax incurred in connection with the deposit of money, arranging a mortgage or credit transaction, assignment of a debt, or insurance (all VAT exempt supplies) was to be treated as relating to a taxable activit y and therefore recoverable.

Many solicitors' only exempt supplies would have been those which were within the scope of regulation 105, and they would therefore not have had to take account of any input tax relating to their financial services activities.

The position has now changed and regulation 105 was abolished with effect form 10 March 1999.If the solicitor's exempt activity (eg, financial services related) is small in relation to other work, input tax incurred in connection with that activity will probably fall within the de minimis limits in regulation 106.

Broadly, these allow a business to earn income from exempt activities of up to almost £43,000 per annum (ie, exempt input tax does not exceed £625 per month).

However, firms will now have to use a partial exemption method to determine whether they fall within the de minimis rule.

This can follow a standard form, or a number of methods which can be agreed with the local VAT office.The change will mainly affect those law firms which conduct discrete investment business.

Broadly, if the remuneration earned from VAT exempt business (such as the activities mentioned above or arranging life and pensions contracts) exceeds the de minimis limit, then input tax recovery will be disallowed for VAT in the same proportion as their revenue from VAT exempt activity bears to their total revenue.

So if VAT exempt investment business activity accounts for 25% of a firm's revenue, 25% of total input tax will be irrecoverable.