How the capital goods scheme works
Andrew Needham looks at the workings of the capital goods scheme.
The capital goods scheme (CGS) is a method of adjusting VAT recovery in line with taxable use. It can cause complications for businesses.
What’s covered by the CGS?
The CGS is designed to adjust the input tax recovered by partially exempt businesses and businesses that have both business and non-business income on specified assets above a certain level over either a five or ten-year adjustment period depending on the asset, in order to reflect the taxable use of that asset. The adjustment calculations have to be carried out annually on the second return following the partial exemption year-end.
If you use or intend to use the asset partly for making taxable supplies and partly for making exempt or non-business supplies, you can only reclaim a proportion of the VAT using your partial exemption and non-business calculations. The CGS is tied into a business’s partial exemption calculation.
The CGS applies to:
- land, buildings and civil engineering works costing more than £250,000
- single computers and items of computer equipment costing more than £50,000
- aircraft, ships, boats or other vessels costing more than £50,000
To fall within the CGS, VAT has to have been reclaimed on land and buildings and it covers lease premiums as well as freehold purchases. The adjustment periods for land and buildings is ten years. It includes parts of buildings, enlargements, alterations, extensions, or annexes and refurbishments of existing buildings.
To be included in the CGS, any refurbishment or enlargement has to be treated as capital expenditure. The capital expenditure in question includes everything which is part of the fabric of the building, but not items merely fixed to it such as furniture and machinery.
Refurbishments and enlargements
The CGS often catches out businesses, and they may get an unexpected bill as a result of the change in taxable use of the land or buildings. But the biggest surprise can come when a business refurbishes or enlarges a property and it costs more than £250,000, as this creates a CGS item where there wasn’t one previously. For example, a property was purchased without VAT and ten years later is refurbished at a cost of £400,000 plus VAT, which the business recovers; this is now included within the CGS.
It can also result in the CGS adjustment period effectively being extended beyond the normal ten years.
Example: Refurbished property
A property is purchased for £600,000 plus VAT, and the VAT is reclaimed. It then becomes a CGS item and is subject to ten-year adjustment period. After eight years it is refurbished at a cost of £280,000 plus VAT.
The refurbishment creates a new CGS item which will last another ten years, effectively extending the CGS adjustment period to 18 years.
Who is affected by the CGS?
In most cases, the CGS only affects partly exempt businesses and entities that have business and non-business income such as charities, but it can also catch out businesses that are normally fully taxable but sell or rent out a property subject to the CGS without opting to tax it. If this happens, they are making an exempt supply and will have to repay some of the VAT that they reclaimed.
This problem can be avoided by opting to tax the property when it comes to be sold. They will then create a taxable supply and there will be no clawback of the VAT reclaimed. However, they will need to charge VAT on the sale.
Make sure clients are aware of the CGS, particularly if they are fully taxable but sell a trading property covered by the CGS within ten years without opting to tax it.
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