Partial Exemption Special Methods (PESMs) are used by many partly VAT-exempt businesses to recover input VAT on a basis that reflects their operations better than the standard method. However, methods agreed many years ago may no longer align with a business’s current structure, income streams, or VAT group composition.
At the CIOT Indirect Taxes Annual Conference in November 2025, HMRC revealed that PESMs that are ten years or older will be subject to review. It signals renewed focus on ensuring that PESMs remain fair and reasonable, given changes in business models and VAT legislation.
According to HMRC, there are 16,000 PESMs officially recorded, but the actual number in circulation is estimated to be closer to 25,000. HMRC have yet to release details of how and when they will conduct this review.
What affected businesses should do now
Review existing PESMs
If your PESM is more than ten years old, expect HMRC scrutiny. Proactively assess whether it still delivers a fair and reasonable result.
Prepare for engagement with HMRC
In our experience, early dialogue can reduce the likelihood of prolonged disputes. Your businesses should gather supporting data and rationale for your current method.
Consider updates to your PESM
Changes in income streams, VAT group membership, or sector-specific frameworks may necessitate a revised PESM.
For example, the financial services, healthcare, charities, and property sectors have unique VAT rules and exemptions. If your PESM was designed under older sector guidance, it may no longer align with current HMRC expectations or industry practice.
The bigger picture
This initiative aligns with HMRC’s broader strategy to modernise VAT compliance and reduce risk. For businesses, it’s an opportunity to ensure that their VAT recovery method is robust, defensible, and aligned with current operations.
This is a big compliance push — don’t wait for HMRC to knock on your door. Recent VAT cases (including Hippodrome Company Limited v HMRC (2025)) show how complex these issues can be, so taking action now could save time and costs later.
Would you like to know more?
If you have any questions about the PESM rules, or would like to discuss your firm’s VAT accounting, please get in touch with your usual BKL contact or Prakash Mangi from our specialist VAT team.
