Andrew Needham looks at the problems of the capital goods scheme and how to avoid some of them.
What is the capital goods scheme?
The capital good scheme (CGS) is a method of adjusting the amount of input tax claimed on a capital asset in line with its taxable use over a period of time. 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; and
- aircraft, ships, boats or other vessels costing more than £50,000.
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 your partial exemption calculation and the adjustment periods are 10 years for land and buildings and 5 years for the other items.
As the taxable use of the asset changes, some VAT has to be repaid to HMRC if the exempt/non-business use increases or some more can be reclaimed if the taxable use increases.
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 businesses that can usually reclaim all of their VAT.
Example: Sale of building
A manufacturing business expands and buys new commercial premises for £400,000 plus VAT of £80,000. The business reclaims all of the VAT in the normal way on its next VAT return. After 6 years the business has out-grown the premises and they sell up and move. As the property is more than 3 years old the sale is an exempt supply.
The business thinks nothing of this until HMRC come to visit and point out that the property is a capital item (a building costing more than £250,000) and its sale was within the 10 year adjustment period for buildings. As the sale was exempt from VAT there was change from taxable to exempt use and 40% of the VAT originally reclaimed (£32,000) has to paid back to HMRC (i.e. 4 years exempt use of the 10 year adjustment period). There will also be interest and penalties.
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.
Partly exempt businesses
Partly exempt businesses have to adjust the VAT reclaimed on any capital items annually in line with any changes in their partial exemption calculation. Sometimes they will pay some VAT to HMRC and sometimes they will be able to claim back some more VAT.
How are these amounts treated for direct tax? 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 is changing. Therefore that must have an effect on the capital allowance computations. The detailed rules are all found within the Capital Allowances Act 2001, at Part 2, 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.
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.
