Have you purchased an expensive capital asset, or assets, for your business?
Did you already acquire or create such an asset, or assets, when you registered for VAT?
If you answered yes to the above then you may have to adjust the amount of VAT you reclaim for your business. The term VAT often comes with a vast amount complexity given the range of rates, rules, reclaims, penalties, and reliefs that make up the landscape for this area of taxation.
It is essential for businesses to understand and manage VAT because you need to ascertain which rate of this tax applies to the goods and services you're selling. It's also vital to keep accurate record-keeping and reporting because your business will likely collect VAT from your customers, only to then pay it to HMRC.
VAT compliance is therefore a critical part of your operations and in this post we explain how you can potentially reclaim VAT on certain capital goods you've acquired. Read on to find out more about the Capital Goods Scheme that applies in such instances, and what you need to adhere to in order to manage this.
The Capital Goods Scheme (CGS) is a UK VAT mechanism that adjusts the amount of input VAT that can be reclaimed on high-value capital assets over several years. This scheme is particularly relevant for businesses that invest in significant capital assets such as land, buildings, computers, IT, and even aircraft given the usage of these goods may vary over time.
Input tax refers to the VAT you pay on the purchase of goods and services where VAT is applicable. If you're VAT-registered, as the purchaser, and your costs are part of your trade of taxable supplies, your Input VAT incurred for the period can be offset against output VAT charged (the VAT you apply to goods and services) for the same timeframe. The difference, where applicable, is then due to HMRC. In instances where your input VAT exceeds output VAT, the difference is recovered from HMRC.
In the case of CGS, the aim is to ensure that the VAT recovered on capital expenditure is in line with the usage of those assets over an adjustment period. This means the initial input VAT claimed when a qualifying asset was purchased, could then be adjusted in the following years where the proportion of taxable use changes. The point being usage of capital items can vary over a timeframe thereby impacting how much VAT can be reclaimed.
The scope of CGS and how it applies to capital goods
The CGS applies to specific high-value capital assets and these include:
Benefits of the CGS
The CGS offers:
How it works
The CGS operates by spreading the initial VAT claimed on these capital assets over a number of years. This is known as an adjustment period. It is 10 years for land and buildings, and 5 years for computers and IT equipment, as well as aircraft and boats.
The adjustment period means you have to alter the amount of VAT you reclaim linked to the proportion of taxable use of the asset. Where your use of an asset varies over a period of time, then you make adjustments to reflect this.
As an example, if you run a legal business and you purchases a commercial property for £500,000 then you may claim back input tax of £100,000 in VAT (at 20%), albeit this is on the assumption that all your activities in it remain VAT-taxable. Then, over the next 10 year timeframe you'd need to assess how much your property was used for taxable, as opposed to exempt, activities.
If you continue to use the building for the same legal activities for 10 years then the CGS adjustments will be zero. There is then no need to adjust the initial input tax claim. However, if in year 5 your business started using 30% the property for exempt activities such as sub-letting, then you'd need to adjust how much VAT you reclaim.
Continuing with the example above, you'd need to repay 30%, or £30,000 of the VAT you'd reclaimed on the property over the remaining 5 years of the CGS adjustment period. Input tax is calculated based on the split of taxable and exempt turnover for the partial exemption tax year in question.
It's therefore adjusted on an annual basis to reflect any potential changes in taxable, exempt, and/or non-business use. Of note, you have to declare such adjustments to HMRC on the second return after the end of the tax year on 5 April.
If you purchase an asset that will be used entirely for non-business purposes then you likely wouldn't claim any input tax. A non-business outcome means there wouldn't be any input tax claims made in relation to the CGS. Input tax may however be claimed if the mix changed to a subsequent combination of business and non-business or exempt uses.
This is probably more likely applicable in the case of land and property assets, and in such a scenario you could either:
If say you purchased a building for £1 million plus VAT and then you claimed that 50% of the input tax was classified as a taxable use, this would disallow the remaining 50% as either non-business or exempt activities. In the case of option 1 the input tax reviewed each year is 20% VAT of £1 million, or £200,000. In the case of option 2 it's 50% of the VAT amount equating to £100,000.
If you expect the taxable amount of your asset to increase over time then it may make sense to include it's full value in the calculations. If you're excluding non-business or exempt elements then you need to keep detailed records of your decision making process.
If you sell an asset before the end of the adjustment period then all of the outstanding adjustments have to be declared in the tax year in which the sale took place. The input tax adjustment will depend on whether the asset sale was taxable, or exempt.
Record keeping and compliance
As all the above potential complexity demonstrates that you'll need to maintain detailed records of your capital assets and any adjustments in their use under the CGS. This is critical to compliance and ensuring your business can accurately calculate your VAT liabilities.
Maintaining accurate records and adjustments can be very time consuming and complex, requiring careful attention to detail. The complexity of the scheme is likely to give rise to errors regarding calculating and adjusting the VAT reclaimed. To avoid compliance issues we'd therefore recommend seeking advice from a professional well versed in such matters.
As a minimum from a compliance perspective you need to include:
The CGS is a very useful mechanism if your business invests in high-value capital assets. This is achieved by ensuring a fair attribution of VAT to taxable supplies and helping businesses manage their VAT liabilities more accurately. However, the benefits of the scheme come with the need for diligence in maintaining detailed records and making accurate adjustments to realise the tax benefits while avoiding potential compliance issues.
The content of this post was created on 01/10/2024.
Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.
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