Andrew Needham looks at the effects of the capital goods scheme for VAT purposes on a commercial property refurbishment.
The capital goods scheme (CGS) is designed to adjust the input tax recovered by partially exempt businesses on specified assets above a certain level over either a five or ten-year period depending on the asset. The adjustments have to be carried out annually.
Amongst the assets covered by the CGS are land and buildings costing £250,000 or more, on which the VAT has been reclaimed. The adjustment period for land and buildings is ten years. It includes the cost of standard-rated services ‘for or in connection with’ the construction of the building or civil engineering work. This includes parts of buildings, enlargements, alterations, extensions, or annexes and refurbishments of existing buildings.
In most cases, the CGS only effects partly exempt businesses, 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.
Refurbishments and enlargements
The CGS often catches out businesses where there is a change in taxable use of the land or buildings. 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. For example, a property was purchased without VAT, and ten years later it is refurbished at a cost of £400,000.
It can also result in the CGS adjustment period being extended beyond the normal ten years.
Example: Property refurbishment
A property is purchased for £600,000 plus VAT, and the VAT is reclaimed. The property then becomes a CGS item, and is subject to a ten-year adjustment period. After eight years, it is refurbished at a cost of £280,000.
The refurbishment creates a new CGS item which will last another ten years, effectively extending the CGS adjustment period to 18 years.
What is included?
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.
When valuing CGS assets which are under construction or refurbished, HMRC states: ‘…If, when you start the CGS, you estimate that the value of relevant supplies will exceed the value threshold, the item will become a capital item. Even if you find later on that the value does not reach the threshold…’
This means that in the event that that a project underruns on costs and comes in under the £250,000 limit, it could still come within the CGS if its forecast costs were more than £250,000.
In addition, HMRC state in respect of multiple refurbishments: ‘…you will need to decide whether the work should be treated as a whole for CGS purposes or whether there is more than one refurbishment’ in which case each refurbishment is looked at separately and may be under the CGS threshold.
Normally HMRC accepts that there is more than one refurbishment when:
- there are separate contracts for each phase of the work; or
- a contract where each phase is a separate option which can be selected or deleted; and
- each phase of work is completed before work on the next phase starts.’
Practical Tip:
If you own a commercial property and enlarge or refurbish it and it costs more than £250,000, it will be covered by the CGS, even if the building was not a CGS item beforehand. It can also extend the period a building is covered by the CGS beyond the normal ten years.
