Capital Goods Scheme for VAT

The Capital Goods Scheme is a VAT rule that requires you to adjust the amount of VAT you reclaim on major capital assets over several years, depending on how you use them. If you purchase or create assets like property, expensive computers, or vessels costing above certain thresholds, this scheme ensures VAT recovery fairly reflects how much you use these assets for taxable business activities over time.

What is the Capital Goods Scheme?

The Capital Goods Scheme (CGS) requires you to spread the initial VAT you claimed on certain expensive capital assets over a number of years. This "adjustment period" accounts for changes in how you use the asset.

The scheme exists because capital items can be used in your business for many years, and during that time the extent to which you use them for making taxable supplies (standard, reduced or zero-rated sales) can change. If the proportion of taxable use increases, you can reclaim more VAT. If it decreases, you must repay some.

Which assets are covered?

The scheme applies to three main categories of capital expenditure:

Land, buildings and civil engineering work

You must use the Capital Goods Scheme if you spend £250,000 or more (excluding VAT) on:

• Buying land, a building, or part of a building
• Buying or constructing civil engineering works (such as roads, bridges, golf courses, running tracks, or installation of pipes for mains services)
• Constructing a building or civil engineering work
• Refurbishing, fitting out, altering or extending buildings or civil engineering works

For alterations, extensions and annexes to buildings, the scheme applies where these increase existing floor space by 10% or more. However, for input tax incurred on or after 1 January 2011, the floor space element was removed from the definition, making it simpler.

Computers and computer equipment

The scheme applies to any single item of computer equipment with a VAT-exclusive value of £50,000 or more.

This means an individual computer or piece of equipment, not a complete network. If you purchase a network where the server, computers and printers together cost over £50,000 but each individual item costs less than £50,000, the scheme does not apply.

Computer software, computerised telephone exchanges, and computer-controlled industrial equipment are not included.

Aircraft, ships, boats and other vessels

From 1 January 2011, the scheme covers capital expenditure of £50,000 or more (excluding VAT) on purchasing, constructing, refurbishing, fitting out, altering or extending aircraft, ships, boats or other vessels.

When the scheme does not apply

The Capital Goods Scheme does not apply if:

• You acquire assets solely for resale
• You spend money on assets which are solely for resale
• Assets are acquired or money is spent on assets which are wholly used for non-business purposes

How the value of a capital item is calculated

The value of a capital item is its VAT-exclusive cost. Only the value of standard or reduced-rated taxable supplies counts.

Important changes took effect from 1 January 2011. Before this date, the value was determined by reference to business-related expenditure only. From 1 January 2011 onwards, the value includes both business and non-business expenditure on an asset.

For example, if a business purchases a building for £1 million with 60% business use and 40% non-business use, before 1 January 2011 only £600,000 counted for CGS purposes. Under the rules from 1 January 2011, the full £1 million counts.

If you incur expenditure on an asset both before and after 1 January 2011, you need to add together the business-related expenditure up to 31 December 2010 and the total expenditure from 1 January 2011 onwards. If this combined sum exceeds the relevant CGS threshold, the asset falls within the scheme.

What counts as capital expenditure?

Capital expenditure is normally expenditure that you capitalise for accounting purposes. HMRC will not usually challenge your capitalisation policy for CGS purposes, except in cases of avoidance or abuse.

Some charities may incur capital expenditure on land and property that is not capitalised in their accounts (for example, heritage buildings or churches) because they cannot freely exploit or dispose of the property. This expenditure that is essentially capital in nature still falls within the CGS.

The adjustable amount of VAT

Before 1 January 2011, only VAT on the business-related expenditure (input tax) fell within the CGS. From 1 January 2011, all of the VAT on an asset falls within the scheme, including both input tax and non-business VAT.

When you only make taxable supplies

You do not need to be partly exempt or have non-business activities when you incur the costs for the CGS to apply. The scheme can affect you even if you initially make only taxable supplies.

For example, if you purchase a building for £300,000 plus VAT and use it for wholly taxable purposes for 6 years, then in year 7 you diversify into an exempt activity (such as insurance) and base your new team in this building, the building remains subject to the CGS. You would then need to make CGS adjustments to reflect the change in use.

What records you need to keep

In addition to standard VAT records, you must keep records showing:

• Description of the capital item
• Value of the capital item
• Amount of VAT incurred on the capital item
• The amount of input tax you reclaimed on the capital item
• The start and end date of each interval, including the first
• When adjustments are due
• The date and value of disposal (if you disposed of the item or partly disposed of it before the end of the adjustment period)

You are not required to keep VAT records for longer than 6 years. However, the CGS requires you to make adjustments up to 10 years later. You should keep records long enough to show HMRC how you calculated each adjustment.

Business changes during the scheme period

Certain changes to your business during a Capital Goods Scheme period will impact the treatment of your capital assets. These include:

• Leaving or joining a VAT group
• Cancelling your VAT registration
• Buying or selling your business
• Selling an asset during the adjustment period

Further detailed guidance on the action you need to take in these circumstances is available in VAT Notice 706/2.

Sources

• Capital Goods Scheme (VAT Notice 706/2)
• The Capital Goods Scheme for VAT

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.