Capital goods scheme VAT: what it covers and how it works

What is the capital goods scheme for VAT?

The Capital Goods Scheme (CGS) is a set of VAT rules for high-value capital items, under which the VAT on an item is reviewed over an adjustment period against the extent to which the item is used in making taxable supplies. Its aim is to provide a fair and reasonable attribution of VAT to taxable supplies and other supplies with the right to recover VAT. ^[1]

The scheme is relevant to a business that acquires, creates or constructs capital items for use in the business and incurs VAT on those items. Because CGS adjustments are reported on the ordinary return, they may form part of the work covered by help preparing and filing returns.

The CGS is separate from the accounting schemes a business may choose to join, such as cash accounting, and the guide to how cash accounting works covers that one.

What are capital goods for VAT purposes?

The CGS applies to capital expenditure on land and buildings with a value of £600,000 or more (exclusive of VAT) which was subject to VAT at the standard or reduced rate.

It also applies to capital expenditure on aircraft, ships, boats and other vessels with a VAT exclusive value of £50,000 or more. For these vessels and aircraft, the scheme covers VAT incurred on the purchase as well as VAT incurred in the course of their manufacture, refurbishment, fitting out, alteration or extension.

The VAT incurred on an asset, whether mixed use VAT or input tax, falls within the CGS, but the scheme only applies to the part of an asset that forms part of the business assets, and VAT on costs allocated entirely to non-business purposes is not eligible for adjustment. The CGS notice also sets out what goes into the value of land or buildings that are acquired, and what to include in the value when a capital item is refurbished or fitted out.

Where a business makes, or intends to make, exempt supplies, it is important to read VAT Notice 706 on partial exemption in conjunction with the CGS notice. The guide to input tax and output tax covers how the amount owed or repaid for a period is worked out.

How the adjustment for each interval is worked out

An adjustment period is the time over which a business reviews the extent to which the VAT incurred on a capital item is used in making taxable supplies. The period is made up of intervals, and first use can only start when VAT has been incurred on the asset.

A business can initially reclaim VAT that is used or to be used to make taxable supplies.

The VAT subject to adjustment in each interval is worked out by dividing the total VAT incurred on the capital item by the total number of intervals in the adjustment period (usually either 5 or 10). Special method percentages are rounded to 2 decimal places.

The CGS notice illustrates how use in later intervals is compared with the recovery set at the start. In its example, a business uses an asset 80% for taxable purposes in interval 6 and is entitled to use an adjustment percentage of plus 17.5% (80% minus 62.5%). In interval 8 the same business uses the asset 40% for taxable purposes and must use an adjustment percentage of minus 22.5% (40% minus 62.5%). The notice deals separately with VAT incurred before and after the first interval.

The actual input tax adjustment required in a subsequent interval is the total VAT on the capital item divided by the number of intervals in the adjustment period, multiplied by the adjustment percentage. In each subsequent interval, the extent of taxable use is compared with the baseline recovery.

Where the adjustment goes on the VAT return

The CGS adjustment amount is included in box 4 of the VAT Return. The adjustment is made in the period after the one in which the partial exemption annual adjustment for the year is made, unless the business has chosen to make its annual adjustment in the last period of its tax year.

A business is not required to keep VAT records for longer than 6 years, but the CGS requires adjustments to be made up to 10 years later. The CGS notice lists records for capital items in addition to those in the VAT guide (Notice 700). Keeping purchase invoices, value workings and each interval's taxable use figures together may make later adjustments easier to check and explain.

Selling a capital item or cancelling registration

If a capital item is sold during the adjustment period, for any remaining complete intervals it is treated as used taxable (at 100%) if the sale was a taxable supply and exempt (0%) if the sale was an exempt supply.

If a capital item is disposed of as a transfer of a going concern, the seller needs to give the new owner the details of the capital item so that future CGS adjustments can be made.

If, on cancelling registration, a business has a capital item covered by the scheme which is still within its adjustment period and it must account for VAT on its business assets, it needs to make a final adjustment. Where VAT on business assets is not accounted for because the VAT on the supply would be less than the monetary limit in the cancellation notice, the business is still treated as having made a supply and still needs to make a final adjustment. Any adjustment for the remainder of the adjustment period goes on the final VAT Return.

Capital goods on the Flat Rate Scheme

The term capital goods also appears in the Flat Rate Scheme, which works separately from the CGS thresholds above. A business using the Flat Rate Scheme does not normally make a separate claim for input VAT, as the flat rate percentage for its trade sector includes an allowance for input VAT. It can recover VAT on any single purchase of capital goods of £2,000 or more, including VAT. ^[2] The value, excluding VAT, of supplies accounted for outside the Flat Rate Scheme, such as the sale of capital goods on which input VAT was reclaimed, is also included in box 6 of the return.