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land, buildings and civil engineering works costing more than £250,000 excluding VAT;
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enlargements, alterations, extensions, or annexes to buildings which increase the floor area by 10% or more, and refurbishments of existing buildings costing more than £250,000 excluding VAT;
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single computers and items of computer equipment costing more than £50,000 excluding VAT; and
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aircraft, ships, boats or other vessels costing more than £50,000, excluding VAT.
Partly exempt businesses
Example 1: Partial exemption calculation
VAT incurred on the purchase of a property is £200,000. Based on the partial exemption recovery percentage in the first year 60% of the VAT is recoverable, so in the first period the recoverable VAT would be £120,000 (£200,000 x 60% = £120,000).
In each subsequent interval, the business is then required to imagine that it has incurred all of the VAT (£200,000) again and undertake a new calculation. In this example, the building will be used entirely for taxable business purposes for the remaining nine adjustment intervals, therefore the CGS recovery percentage will be 100% in the remaining intervals. This means that the business will be able to reclaim:
(100% - 60%) x £200,000/10 = £8,000
This VAT is reclaimed at the end of each of the remaining 9 intervals under the CGS - reflecting the increased taxable business use of the building.
Interaction with direct taxes
How are these amounts treated for direct tax purposes? The original asset purchased is probably within the capital allowances computation, and would have been included at the net cost plus any irrecoverable VAT in the year of acquisition. As the asset moves through the CGS periods the amount of irrecoverable VAT changes. Therefore that must have an effect on the capital allowance computations. The detailed rules are all found in the Capital Allowances Act 2001 (at Chapter 18). Generally, these provisions say that a payment to HMRC is treated as an asset addition, and a repayment from HMRC is treated as an asset disposal and the tax adjusted accordingly.
Property trap
The danger with the CGS is that it does not just apply to businesses that are normally partly exempt; it can also catch out businesses that can usually reclaim all of their VAT.
Example 2: Sale of business premises
A manufacturing business expands and buys new commercial premises for £400,000 plus VAT of £80,000. It reclaims all the VAT in the normal way on its next VAT return, as it is using the property in its fully taxable business. After six years, the business has out-grown the premises and they sell up and move to a bigger property. As the property is more than three years old, the sale is an exempt supply and the property is sold without VAT being charged.
The business thinks nothing of this until HMRC come to visit and point out that the property is a capital item for the purposes of the CGS (a building costing more than £250,000) and its sale was within the ten year adjustment period for buildings.
As the sale was exempt from VAT, there was a deemed change of use from taxable to exempt use and 40% of the VAT originally reclaimed (£32,000) has to paid back to HMRC. This is because the remaining four years of the CGS is treated as exempt use out of the ten year adjustment period and therefore 4/10 or 40% of the VAT originally claimed has to be repaid to HMRC.
This sum will have to be paid to HMRC. plus interest and penalties, because the VAT was not accounted for correctly under the CGS at the time the property was sold.
This pitfall can also cause problems when a business decides to rent out part of its premises during the CGS adjustment period, as it will be making an exempt supply of part of the property.
This problem can be avoided by opting to tax the property when it comes to be sold. This will then create a taxable supply of the property and there will be no clawback of the VAT previously reclaimed. However, they will need to charge VAT on the sale.
Transfer of a going concern
The CGS does not cease to apply because an asset is sold in a transaction that is outside the scope of VAT because it is the transfer of a going concern. The purchaser of the business must continue the annual adjustments for the balance of the adjustment period.
This means that the purchaser must ensure that the records transferred include the necessary details of the date of acquisition, the input tax incurred at that time, and the percentage of that tax which was recovered by the vendor. It also means that the purchaser may be able to reclaim, or have to pay, some of that tax with a consequent reduction or increase in the effective cost to him of the asset. So when buying an asset, the new owner will have to take into account the potential changes in VAT recovery made by the original owner.
Practical Tip:
If you own an item that comes within the CGS, make sure you monitor any change of use and adjust the VAT reclaimed. If you are selling a property covered by the CGS, don’t forget to opt to tax it before the sale, and remember to adjust your capital allowance claim.