Have you remembered the 10-year rule?

Businesses that fall under the Capital Goods Scheme (CGS) may apply the rules correctly at first. But many get caught out by the need to review their position in subsequent years.

“If you incur significant capital expenditure on certain kinds of costs, you become subject to the CGS,” explains Moore Stephens VAT expert Robert Facer. “The CGS most often arises in connection with buying, building, extending, altering, refurbishing or fitting-out a property, but can also apply to computers, boats and aircraft.”

For property related capital expenditure, the CGS applies if the cost is £250,000 plus VAT or more.  The threshold is £50,000 for other types of CGS asset. VAT on the costs is then reclaimed under the normal rules, so partially exempt businesses would apply their usual partial exemption methodology.

Ongoing monitoring
“But there’s one point that often catches people out,” Robert says. “Every year during the life of the CGS asset (ten years for property and five years for other CGS assets), the business has to monitor how it uses the asset – and potentially adjust its initial VAT recovery.”

CGS adjustments are based on the extent to which the asset is used for taxable business purposes, which is normally measured by reference to the business’ partial exemption recovery rated. For example, a business refurbishes its office at a time when it is able to recover 60% of its VAT, but a year later its VAT recovery has fallen to 40%. It would have to make a CGS adjustment to reflect the reduced recovery rate, which in this case would be 2% of the VAT originally reclaimed (i.e. 60%-40% divided by 10 years). Adjustments can work both ways, so if taxable use increases, a corresponding beneficial CGS adjustment can be made.

Overlooked requirement
“The CGS requirements are often overlooked,” Robert says. “Clients incur the cost, apply their partial exemption method and, understandably, think that’s the end of the story. But it isn’t. If adjustments are not made, reclaimable VAT can be lost.”

Alternatively, if HMRC should have been repaid VAT, the business could face penalties and interest charges, as well as an unexpected VAT bill. “HMRC are now much more focused on CGS adjustments than in the past,” Robert warns. “Businesses need to make sure they are applying the CGS rules properly throughout the full CGS period.”

Another point that is often overlooked is that, if a business is acquired as a going concern, the previous owner’s CGS obligations may be inherited, which could result in the acquirer having to pay VAT to HMRC. Consequently, the CGS should always form part of any due diligence.

The CGS position should be considered carefully. It may be possible to stay outside the CGS rules by analysing the capital expenditure, as certain costs (such as carpets and moveable furniture) do not count towards the threshold. If the CGS does apply, you should consider how the CGS adjustments are calculated, as your partial exemption recovery rate may not be the most appropriate measure of the asset’s taxable use.

For advice on how the CGS applies to your business, please contact Robert Facer.

This is the third article in our series focused on partial exemption. Watch out for the final article in this series covering recent HMRC policy changes.