Capital Goods Scheme for VAT – how does it work?

10 Jun 2020

Understanding the Capital Goods Scheme (CGS) for VAT is crucial for businesses dealing with high-value capital assets, especially those involved in partially exempt activities or with changing business use. This guide will walk you through how the scheme works, why it’s important and its interaction with capital allowances, ensuring you maintain compliance and optimise your VAT position.

At its core, the VAT Capital Goods Scheme adjusts the amount of input VAT you can recover on significant purchases. While businesses can usually reclaim input VAT (tax incurred on most purchases made by VAT-registered firms) from HMRC in full, the CGS introduces a mechanism to correct this recovery if the asset’s use changes over time. To ensure your business is fully compliant with all regulations and effectively managing your tax obligations, explore our comprehensive VAT services.

The scheme primarily affects partially-exempt businesses and firms whose assets were used for both non-business and business purposes at the time of purchase. However, it can also apply to any business that acquires such assets if they later diversify into an exempt activity at any point during the ‘adjustment period’.

The objective of the CGS is simple: to ensure the VAT recovered accurately reflects the actual use of the asset between taxable and exempt supplies over its entire adjustment period. It does not apply to assets acquired for resale or those used wholly for non-business purposes.

What does the Capital Goods Scheme apply to?

The Capital Goods Scheme applies to specific types of high-value assets. It’s vital to identify these upfront to ensure correct VAT treatment from the outset.

The scheme applies to:

  • Land and Buildings:
    • Applies where expenditure of £250,000 or more (excluding VAT) is incurred on:
      • Land, a building, or part of a building, or civil engineering work.
      • Constructing a new building or civil engineering work.
      • Extensive refurbishment, fitting out, alterations, or extensions to a building or civil engineering work.
    • Civil engineering work examples include: roads, running tracks, golf courses, and the installation of pipes for water services.
  • Computer Equipment:
    • The scheme applies to individual items costing £50,000 or more (excluding VAT).
    • VAT on smaller items is reclaimed under the usual input VAT recovery methods.
    • Important: Computer software and computerised equipment, such as a computerised phone exchange, are generally not included under the CGS.
  • Aircraft, Ships, Boats and Other Vessels:
    • The scheme applies where more than £50,000 (excluding VAT) is spent on purchasing, constructing, refurbishing, fitting out, altering, or extending any form of aircraft, ship, boat or other vessel.

Adjustments and essential record-keeping

Even if your business is not partially exempt when an asset is purchased, it’s crucial to understand that the CGS can still apply later if your business activities change. Therefore, meticulous record-keeping is paramount for any asset covered by the scheme.

While standard VAT records typically need to be kept for six years, HMRC requires businesses to retain CGS-related records for longer – sometimes up to ten years, as adjustments can be made throughout the entire adjustment period. These records enable HMRC to verify how each adjustment was calculated.

Records should include:

  • A detailed description of the capital item.
  • The total value of the capital item (excluding VAT).
  • The exact amount of VAT incurred on the capital item.
  • The amount of input tax initially reclaimed on the capital item.
  • The start and end date of each ‘interval’ within the adjustment period.
  • The date and value of disposal (if the item was disposed of, or partly disposed of, before the end of the adjustment period).

The amount of reclaimable VAT under the scheme hinges on how the asset is used over the adjustment period – specifically, how its use varies between taxable and non-taxable (or business and non-business) supplies.

The adjustment period is the fixed time over which your business must review the extent to which the asset is used in making taxable supplies. This period is divided into ‘intervals’. The length of these intervals depends on the asset type:

  • Five intervals: For computer equipment, ships, and aircraft.
  • Ten intervals: For land and buildings, and all other capital items falling under the scheme.

The first interval begins on the day the asset is first used and concludes on the day before the start of your next partial exemption tax year. Subsequent intervals generally align with your partial exemption tax years.

Input tax is recovered in the first interval in the normal way. An annual adjustment is then required for subsequent intervals if the proportion of the asset used in making taxable supplies differs from that in the first interval. This can result in either an extra VAT payment to HMRC or the recovery of additional input VAT.

Practical example: How it works

Let’s illustrate the CGS with a common scenario:

Imagine a business purchased a commercial property for £300,000 (excluding VAT of £60,000).

  • Initial Recovery (First Interval):Based on the partial exemption recovery percentage at the first interval, let’s say 80% of the VAT was recoverable. The business would reclaim £48,000 of input VAT (£60,000 x 80%).
  • Subsequent Adjustment (Second Interval Onwards):At the second interval, the building’s use changes significantly. It is now wholly used for taxable purposes and is projected to continue this use for the remaining nine adjustment intervals.
    • The recovery percentage has therefore increased to 100%.
    • The business can reclaim further input VAT under the scheme at each remaining interval. The calculation for each interval’s additional reclaim is: ((New Recovery % - Initial Recovery %) X Total VAT / Number of Intervals)
    • In this case: ((100% - 80%) x £60,000 / 10) = £1,200
    • This additional £1,200 VAT can be reclaimed at the end of each of the remaining nine intervals, reflecting the building’s increased taxable use.

Capital Allowances and the Capital Goods Scheme

When an asset falls within the Capital Goods Scheme, it may also be eligible for capital allowances.

On purchase, such an asset should be included in your capital allowances computation at its net cost plus any irrecoverable VAT in the year of acquisition.

However, CGS adjustments made at each subsequent interval, which typically result in either an extra VAT liability or a rebate, have a direct impact on your capital allowances computation.

  • If a CGS adjustment results in a payment to HMRC (meaning less VAT was originally recoverable than thought), this amount is treated as an asset addition for capital allowances purposes.
  • If a CGS adjustment results in a repayment from HMRC (meaning more VAT was originally recoverable), this amount is treated as an asset disposal.

The date of this addition or disposal for capital allowance purposes is typically the last day of the scheme adjustment period for that interval.

Furthermore, if first-year allowances (like Full Expensing for qualifying plant and machinery) or the Annual Investment Allowance (AIA) were claimed on the original asset, these same allowances may also apply to any CGS adjustment that results in an cleanaddition to the capital allowances computation.

Potential pitfalls and scenarios

The CGS isn’t just for partially exempt businesses. It can unexpectedly catch out businesses that typically reclaim 100% of their VAT.

Consider this scenario:

  • A business is entitled to fully reclaim its VAT and disposes of its premises after owning it for six years.
  • Having been purchased new for £300,000, the VAT of £60,000 was reclaimed in full on the purchase.
  • As the property is more than three years old, the sale itself is usually an exempt supply. However, because the sale was exempt from VAT, there is a ‘deemed change of use’ from taxable to exempt use.
  • This impacts the amount of input VAT that could be reclaimed on the original purchase. As the asset was sold six years into the ten-year scheme, 40% of the VAT originally claimed (£24,000) would have to be repaid to HMRC.

To avoid this clawback, businesses might consider ‘opting to tax’ the property. By creating a taxable supply on the sale (charging VAT on the sale), none of the previously reclaimed input VAT would be clawed back. This is a complex decision and requires careful consideration.

Need expert guidance on the Capital Goods Scheme?

Navigating the intricacies of the Capital Goods Scheme can be challenging, and errors can lead to unexpected VAT liabilities. Whether you’re acquiring a new high-value asset, undergoing changes in your business activities, or considering a property disposal, our experienced tax team is here to help.

We provide tailored advice to ensure your compliance, accurately calculate VAT recoveries, and help you understand the full financial implications for your business. Our expertise extends to comprehensive tax planning strategies designed to optimise your financial position.

Don’t risk incorrect VAT recovery or penalties. Speak to our VAT experts today.

Contact Our Tax Team for Advice.

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