Find out how the VAT capital goods scheme (CGS) works, the items covered by the scheme, the rules and how adjustments and disposals are affected.
1.1 What this notice is about
This notice explains how the capital goods scheme (CGS) works including which items are covered by the scheme.
1.2 Who should read this notice
You should read this notice if you acquire, create or construct capital items for use in your business and you incur VAT on those items. The aim of this scheme is to provide a fair and reasonable attribution of VAT to taxable supplies and other supplies with the right to recover VAT. Capital items can be used in your business over a period of years. Over the years the extent to which you use these in making taxable supplies can vary.
If you make, or intend to make exempt supplies, it’s important to read VAT Notice 706: partial exemption in conjunction with this notice.
1.3 How the scheme works
The scheme requires adjustments to be made to the initial amount of VAT claimed. This reflects the differences in the use of capital items over a period of time. This period is known as the ‘adjustment period’. If, during the adjustment period there’s any change in the proportion of taxable use then you must make an adjustment to your input tax to take account of this.
1.4 When the scheme does not apply
The scheme does not apply if:
- the assets are acquired solely for resale
- you spend money on assets which are solely for resale
- assets are acquired, or you spend money on assets, which are wholly used for non-business purposes
1.5 If you make only taxable supplies
You do not have to be partly exempt or (for capital costs incurred after 1 January 2011) have non-business activities when you incurred the costs for the CGS to apply. For example, you may use a building purchased for £300,000 plus VAT for wholly taxable purposes for 6 years. In year 7 you diversify into an exempt activity - for example insurance - and base your new insurance team in this building. The building remains subject to the CGS and CGS adjustments may now be required.
2. Record keeping
2.1 What records you need to keep
In addition to those records shown in the VAT guide (Notice 700), your records should include the following:
- description of the capital item
- value of the capital item
- amount of VAT incurred on the capital item
- the amount of input tax reclaimed by you 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 the item was disposed of or partly disposed of before the end of the adjustment period)
2.2 How long you need to keep records
You are not required to keep VAT records for longer than 6 years. But the CGS requires you to make adjustments up to 10 years later. You should keep records long enough to show us how you calculated each adjustment.
3. Scope of the CGS
3.1 Items covered by the scheme
Assets covered by the scheme are known as ‘capital items’.
The CGS applies to capital expenditure on land and buildings with a value of £250,000 or more (exclusive of VAT) which was subject to VAT at the standard or reduced rate. The purchases in question are:
- an interest supplied to an owner in land, a building or part of a building or a civil engineering work - civil engineering work should be given its everyday meaning, which includes such items as roads, bridges, golf courses, running tracks and installation of pipes for connection to mains services
- expenditure incurred in the construction of a building, part of a building or a civil engineering work
- alterations, extensions and annexes to buildings which increase the existing floor space by 10% or more (for input tax incurred on or after 1 January 2011 the CGS definition relating to expenditure in this category has been simplified by removing the floor space element of the definition)
- for input tax incurred on or after 1 January 2011, the CGS has been extended to include alterations, extensions and annexes to civil engineering works
- capital expenditure on services and goods affixed to the building in the course of refurbishing or fitting out a building (for input tax incurred on or after 1 January 2011 it no longer matters whether goods are affixed to a structure or not, only whether the expenditure has been capitalised)
- for input tax incurred on or after 1 January 2011 the CGS has been extended to include refurbishments of civil engineering works
The CGS also applies to:
- any computer with a VAT exclusive value of £50,000 or more - ‘computer’ means a single item of equipment rather than a complete network (computer software and computerised equipment such as a computerised phone exchange or computer controlled blast furnace are not included)
- with effect from 1 January 2011, capital expenditure on aircraft, ships, boats and other vessels with a VAT exclusive value of £50,000 or more - as well as VAT incurred in respect of the purchase of such assets, the scheme also includes VAT incurred in the course of their manufacture, refurbishment, fitting out, alteration or extension
4. Values and definitions
4.1 What we mean by ‘capital expenditure’
This is normally expenditure capitalised for accounting purposes. We will not normally challenge your capitalisation policy for the purposes of the CGS, except in cases of avoidance or abuse.
In some cases charities may incur expenditure of a capital nature on land and property which is not capitalised in their accounts (for example certain heritage buildings or churches). This is generally because the charity does not have unfettered freedom to exploit or dispose of the land or property concerned. This will not prevent expenditure that’s essentially capital in nature from being adjusted under the CGS.
4.2 The value of a capital item
This is the VAT exclusive value of the item. Only the value of standard or reduced-rated taxable supplies is considered.
Before 1 January 2011, the value of a capital item was determined by reference to the business-related expenditure. With effect from 1 January 2011, the value is determined by reference to total expenditure on an asset. This includes both business and non-business expenditure on an asset.
A business purchases a building for £1 million and incurs £200,000 VAT. The building is to be used for 60% business purposes and 40% non-business purposes (for example, charitable use). Before 1 January 2011, £600,000 (60% of £1 million) determined the value for CGS purposes. Under the new rules that took effect from 1 January 2011, all of the expenditure on the building (£1 million) is the value for CGS purposes. As the CGS threshold for buildings remains at £250,000, the building is a capital item in both scenarios.
4.3 Expenditure incurred on a capital item before and after 1 January 2011
It will be necessary to determine the amount of business-related expenditure incurred on the asset up to 31 December 2010 and the total amount of expenditure (business and non-business) incurred on or after 1 January 2011. If the sum of these amounts exceeds the relevant CGS threshold, the asset falls within the CGS.
4.4 The adjustable amount of VAT
Prior to 1 January 2011, only VAT on the business-related expenditure on an asset (input tax) fell within the CGS. With effect from 1 January 2011, all of the VAT on an asset (in this instance input tax and non-business VAT) falls within the CGS.
Following on from the example, prior to 1 January 2011, input tax of £105,000 (17.5% of £600,000) fell within the CGS. With effect from 1 January 2011, VAT of £175,000 (17.5% of £1 million) falls within the CGS (£200,000 after the increase in the standard rate of VAT to 20% on 4 January 2011).
If expenditure is incurred both before and after 1 January 2011, the VAT on the business-related expenditure incurred up to 31 December 2010 and the total VAT incurred on the asset on or after 1 January 2011 fall within the CGS.
4.5 Estimate the value
If you do not know whether a project exceeds the value threshold for the CGS until all invoices have been received you’ll need to estimate the value of the supplies you’ve received. This may happen with construction projects and refurbishments where VAT is incurred over a period of time and also with contracts that include a retention clause. A retention clause involves a proportion of the contract price being held back and only paid when the work has been satisfactorily completed.
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, the item remains in the scheme and you should continue to make adjustments as necessary.
If you do estimate the value of a capital item you’ll need to keep all the documents you based your estimation on, such as a contract, as our officer may ask to see it.
4.6 What you should include in the value of land or buildings that you acquire
Only include the value of the interest in the land or building supplied to you, if the supply was taxable and not zero-rated. Do not include any associated costs such as legal or estate agency fees.
In calculating the value of the interest supplied to you in the land or building, you do not need to include the value of any rent or service charges unless it’s:
- been paid or is payable more than 12 months in advance
- invoiced by the supplier for a period of more than 12 months - in that case, you should include the value of rent or service charges when calculating the value of the capital item
4.7 What you should include in the value of a constructed building or civil engineering work
You should include the total VAT exclusive cost of any of the following supplies made to you:
- the interest in the land, if the supply to you was taxable (other than zero-rated)
- taxable (other than zero-rated) goods and services supplied for, or in connection with, the construction of the building or civil engineering work
You should include all the costs involved in making the building ready, such as:
- professional and managerial services including architects, surveyors and site management
- demolition and site clearance
- building and civil engineering contractors’ services
- materials used in the construction
- equipment hire
- fitting out, including the value of any fixtures
4.8 If you’ve purchased land and constructed a building on it
If you’ve purchased land and constructed a building on it, this is treated as one capital item.
4.9 What to include in the value of an alteration, extension or annex where the value of the goods and services received is £250,000 or more
You should include the total value of all taxable (other than zero-rated) goods or services supplied to you for, or in connection with, the alteration, extension or annex.
You should include all the costs involved in making the building or civil engineering work ready. See examples at paragraph 4.7.
4.10 What you should include in the value if a capital item is refurbished or fitted out
You should only include the value of capital expenditure on the taxable (other than zero-rated) supply of services and of goods affixed to the building or civil engineering work supplied to you for or in connection with the refurbishment or fit out.
However, for capital items where the costs are incurred on or after 1 January 2011 there is no longer a requirement for goods used for the refurbishment to be affixed to the building.
You should include all the costs involved in making the refurbished or fitted out building ready. See examples at paragraph 4.7.
4.11 ‘Goods affixed’ to the building
These are goods which become part of the fabric of the building. Generally these are items that are sold with the property and are not portable or easily removed.
‘Goods affixed’ does not include items secured for safety or security reasons or computers or computer equipment. These may be subject to the CGS in their own right.
The following lists will help you to decide whether an item is ‘affixed’.
This list is not exhaustive and the deciding factor is usually whether the item becomes part of the fabric of the building. Common inclusions are:
- materials to build
- internal and external walls
- roofs and ceilings
- floors and hard flooring
- permanent partitioning
- ‘built in’ storage such as cupboards or shelving
- air conditioning
- decorative features
Common exclusions are:
- office furniture
- storage unless it’s ‘built in’
- computers and computer equipment
- factory and office machinery
Again, this list is not exhaustive.
For capital items where the capital costs are incurred on or after 1 January 2011 there is no longer a requirement for goods used for a refurbishment to be affixed to a building. For capital items where the capital costs were incurred before 1 January 2011, this treatment is already allowed in relation to the ‘goods affixed’ condition by concession and is adopted by most businesses.
4.12 If the refurbishment is in phases
If you do this you’ll need to decide whether the work should be treated as a whole for CGS purposes or whether there is more than one refurbishment. If you think that each phase is really a separate refurbishment then they should be treated separately for CGS purposes.
Normally there’s more than one refurbishment when either:
- there are separate contracts for each phase of the work
- a contract where each phase is a separate option which can be selected, and each phase of work is completed before work on the next phase starts
A refurbishment which is only undertaken in phases because the building is occupied and where the contractors work on 1 floor at a time is normally considered to be only one refurbishment.
4.13 Regular refurbishments
These are sometimes referred to as ‘rolling refurbishments’.
Problems may occur if successive refurbishments begin before each adjustment period has expired. If this happens you should either:
- treat the original refurbishment as ‘destroyed’ (see paragraph 9.8) if there is nothing left of the earlier refurbishment or this earlier work is stripped out or replaced - the effect of this is that no further adjustments would be required to the input tax on the previous refurbishment
- continue to make adjustments for the remainder of the adjustment period if elements of the earlier refurbishment are retained
4.14 What to include in the value of computers
You should include any delivery and installation costs, unless these are supplied separately. If you import a computer you should use the value for VAT at importation. This will include any import duty payable.
5. Option to hold all or part of an asset outside the VAT system
5.1 What this option is
You may make a choice, when acquiring an asset, to exclude all or part of it from your business’s assets, by holding it privately or as a non-business asset. If such an option is made, the excluded element never forms part of your business assets. The option is only available if you have private or non-business activities.
If all or part of an asset is excluded from your business assets because you hold it for private or non-business use, the costs and related VAT are also excluded from the VAT system. Expenditure relating to the element that’s been excluded from your business does not count towards the CGS threshold, but the related VAT is always non-deductible and will not benefit from adjustment if taxable use increases.
5.2 When and how the option is made
The choice to exclude any part of an asset from your business’s assets must be made at the time when the relevant expenditure is incurred and should be recorded to avoid the risk of future disputes. Evidence might include minutes of a board meeting, a note in your VAT file or similar contemporaneous material to evidence your decision.
5.3 How an option to hold part of an asset outside the business interacts with the CGS
The CGS will only apply to that part of the asset that forms part of your business assets and you’ll need to take into account the business or non-business use and taxable or exempt use of that part in the CGS adjustment period, as described in section 6.
5.4 CGS rules and expenditure initially allocated entirely to non-business activities
VAT on costs allocated entirely to non-business purposes is not eligible for adjustment under the CGS rules.
6. Intervals and the adjustment period
6.1 The adjustment period
An adjustment period is the time over which you review the extent to which a capital item is used in making taxable supplies.
6.2 The adjustment periods
- 5 intervals for computers
- 5 intervals for ships and aircraft
- 10 intervals for all other capital items
For capital items where the period of adjustment (under the old rules) had not started before 1 January 2011 there are new rules which align the period of adjustment with the owner’s interest in the asset (see paragraph 6.3).
For capital items where the period of adjustment (under the old rules) had started before 1 January 2011 there were 5 intervals for an interest in land, buildings or civil engineering works which had less than 10 years to run when they were acquired.
6.3 Aligning the period of adjustment with your interest in an asset
In some cases, the period of time that you have an interest in an asset is less than the normal period of adjustment under the CGS (10 years for land and buildings, 5 years for ships and aircraft). From 1 January 2011 the adjustment period is aligned with your interest in the asset.
Where the number of intervals comprising the normal period of adjustment (5 or 10 intervals) exceeds the number of complete years that you have an interest in the asset by more than 1, the period of adjustment is reduced to a number of intervals equal to the number of complete years plus 1, down to a minimum of 3 intervals.
The period of adjustment is reduced to the number of whole years plus 1 to cater for any residual interest (in this instance any remaining interest after whole years have been taken into account) in the capital item to help ensure a fair recovery of VAT.
Example - a business acquires a 7 year interest in a building that falls within the CGS
The normal period of adjustment for a building is 10 intervals. However, the business only has a 7 year interest in the asset. As 10 exceeds 7 by more than 1, the period of adjustment for the building is reduced to the number of complete years plus 1, that is, 8 intervals.
If your interest in an asset is for fewer than 3 intervals then the asset does not fall within the CGS. This is because the CGS only deals with capital expenditure, which is generally expenditure that will be used by a business for a minimum of 2 years and this normally equates to 3 intervals under the CGS.
6.4 The first interval
For capital items for which the period of adjustment (under the old rules) had not started before 1 January 2011 the first interval is a period of time that starts with first use of the asset. This is a common start date for all categories of capital items.
For capital items for which the period of adjustment (under the old rules) had started before 1 January 2011 the first interval is a period of time that starts on either the date:
- of purchase, importation or acquisition
- the owner first uses the item where the item is constructed, altered, extended, refurbished or fitted out
- of registration (or inclusion into an existing VAT group), where the owner is not a registered person when they first use the item
‘Use’ includes any use in the business.
First use will correspond with the first time that a capital item or part of such asset is used for business or non-business purposes. In the case of a building, this would normally correspond with the earlier of the granting of a lease or licence or physical occupation. The only pre-condition is that first use can only start when input tax has been incurred on the asset.
6.5 End of first interval
The first interval ends on the day before the start of your next partial exemption tax year.
With effect from 3 July 1997, if there is no change of use between the first and the second interval and the length of the 2 intervals combined is less than 12 months, the 2 intervals are rolled together and treated as the first interval.
You do not need to make any adjustment after the end of the first interval. Your normal partial exemption (or business or non-business calculation if applicable) will determine the amount of VAT you can recover at the end of the first interval. CGS adjustments are only made after the end of subsequent intervals.
6.7 The subsequent interval
The intervals following the first interval are called subsequent intervals and are normally in line with the partial exemption tax year.
6.8 When an adjustment is required
If, in any subsequent interval, the extent to which you use an item in making taxable supplies increases or decreases when compared to your initial use, you’ll have to make a CGS adjustment. You only make CGS adjustments to subsequent intervals. No adjustments are made after the end of the first interval.
6.9 When the adjustment period ends
If you continue to use a capital item in your business for the whole of the adjustment period, the period will usually end after the fifth or the 10th interval as explained in paragraph 6.2 and paragraph 6.3. You should make your adjustment for the final interval in the normal way (see section 8) on the return for the second prescribed accounting period after the end of the interval and from then on no further adjustments are needed.
6.10 Changes in use after the final interval
You do not need to make any further adjustments for changes in use after the final interval.
7. Work out the adjustments
7.1 Work out how much input tax you can initially reclaim
You can initially reclaim VAT that’s used or to be used to make taxable supplies. This involves the following steps:
Step 2 is to establish the extent to which input tax carried forward from step 1 is used or to be used to make taxable supplies. If the asset is used:
- only to make taxable supplies, all of the input tax is deductible
- only to make exempt supplies, none of the input tax is deductible
- to make taxable and exempt supplies, you’ll need to carry out a partial exemption calculation - partial exemption calculation is normally carried out in accordance with a partial exemption method and, unlike the BNB calculation, is normally subject to an annual adjustment (see VAT Notice 706: partial exemption)
Following on from the example at paragraphs 4.2 and 4.4 (building cost £1 million and 60% business use intended), the building has 60% business use involving only the making of taxable supplies in the year of acquisition (the first interval under the CGS).
Initially the business needs to calculate how much of the VAT incurred on the building is deductible following the steps above. As the building will be used for 60% business purposes, £120,000 VAT can be treated as input tax. As the business activities involve only making taxable supplies, all of this input tax is deductible.
The default position for determining how much VAT is deductible on costs is as set out above. Step 1 requires you to select your own fair and reasonable BNB calculation. Step 2 requires you to determine recoverable VAT in accordance with a partial exemption method, assuming you’re partly exempt - either the turnover-based standard method which is set out in legislation or, alternatively, a special method which must be approved by HMRC.
However, for VAT incurred on or after 1 January 2011, HMRC is now able to approve a method covering BNB calculations. Where you’re also required to carry out partial exemption calculations, HMRC can also approve use of one single agreement covering the business’s BNB and partial exemption calculations. This is known as the combined method. For more information see VAT Notice 706: partial exemption.
7.2 The ‘baseline’ recovery of VAT established at the end of the first interval
With effect from 1 January 2011, you need to calculate the amount of deductible VAT on the asset following the 2 steps in paragraph 7.1 (or your approved combined method). The baseline recovery percentage is the amount of deductible input tax on the asset expressed as a percentage of the total VAT on the asset, in this instance input tax and non-business VAT.
Before 1 January 2011, you were required to calculate an amount of input tax that was deductible on a capital item following the 2 steps in paragraph 7.1. However, the baseline recovery percentage for the CGS was established by the amount of deductible Input Tax, expressed as a percentage of the total input tax on the capital item.
7.3 Amending an incorrect initial claim for VAT in the first interval
The ‘baseline’ recovery of VAT on a capital item is the amount that’s deductible in the tax year or years that it was incurred in. This is then adjusted up or down with changes of use in subsequent intervals. If there were errors in the initial deduction then:
- they can be corrected only by adjustments to that initial deduction, not by making adjustments under the CGS that treat that initial deduction as if it had been correct
- if they’re outside the capping limits, they cannot be corrected at all
For more information on capping, see section 14 of VAT Notice 706: partial exemption.
Whether or not any errors in the initial deduction can actually be corrected, subsequent interval adjustments will always refer back to the corrected baseline. This may lead to situations where adjustments are due that common sense would say should not be. It should be considered however, that adjustments should not be made or allowed where they would result in the claiming of more than all, or less than none of the input tax effectively adjusted in that interval.
A business buys a capital item and recovers 70% of the VAT incurred. More than 4 years later it’s found that this deduction is in error and only 30% should have been recovered. This error cannot be corrected as it’s capped. In interval 6 the business uses the asset 50% for taxable purposes. Despite the fact that it has already recovered 70% of the VAT on the item it’s still entitled to use an adjustment percentage of plus 20% in the interval 6 adjustment.
7.4 Measure the extent of taxable use in subsequent intervals
You’re required to review the extent to which VAT is deductible on the asset in each subsequent interval. To do this you must imagine that you’ve incurred all of the VAT on the asset again and repeat the steps in paragraph 7.1 taking account of any changes in use.
For capital items whose adjustment period started on or after 1 January 2011 you need to review your BNB calculation in addition to your partial exemption calculation for the capital item in each subsequent interval and account for any required adjustment in the normal way.
In each of the subsequent intervals (between 2 and 9 depending on the individual item and when it was acquired) the extent of taxable use (or non-business use if the item was purchased after 1 January 2011) determined under the longer period partial exemption calculation (or business or non-business calculation if applicable) is compared with the ‘baseline’ recovery. The difference is called the ‘adjustment percentage’.
7.5 How to calculate the actual adjustment you must make
The actual input tax adjustment (if any) required in a subsequent interval is calculated by dividing the total input tax (or total VAT if incurred after 1 January 2011) on the capital item by the total number of intervals in the adjustment period (usually either 5 or 10). You then multiply by the adjustment percentage. Thus the calculation is:
For capital items whose adjustment period begins before 1 January 2011:
Total input tax on the capital item
Number of intervals in the adjustment period x the adjustment percentage
For capital items whose adjustment period begins on or after 1 January 2011:
Total VAT on the capital item
Number of intervals in the adjustment period x the adjustment percentage
With effect from 1 January 2011, all of the expenditure on the building falls within the CGS. The baseline recovery percentage needs to be determined by reference to the amount of deductible input tax on the asset expressed as a percentage of the total VAT on the asset:
£120,000/£200,000 = 60%.
In each subsequent interval the business is then required to imagine that it’s incurred all of the VAT (£200,000) again and repeat the steps in paragraph 7.1. As the building will be used entirely for taxable business purposes, the CGS recovery percentage will be 100% in the remaining intervals. This means that the business will be able to reclaim:
(100% - 60%) x £200,000/10 = £8,000
at the end of each of the remaining 9 intervals under the wider CGS - reflecting the increased taxable business use of the building.
Prior to 1 January 2011, only the expenditure allocated to business activities and related input tax fell within the scope of the CGS. The baseline recovery percentage was determined by reference to the amount of deductible input tax expressed as a percentage of total input tax, which is 100% in this example. The business was then required to imagine that it had incurred all of the input tax (£120,000) again and review the extent to which it had been used to make taxable supplies in each subsequent interval. In this case, the input tax was used only to make taxable supplies in each subsequent interval and so no further adjustments were necessary under the old CGS rules, even though business use of the building had increased.
If you incur expenditure on your capital asset both before and after 1 January 2011 you’ll have a ‘split’ capital item. Input tax incurred up to 31 December 2010 must be reviewed in light of any change in the mix of taxable and exempt supplies made. VAT incurred on or after 1 January 2011 must be reviewed separately in light of both changes in business use in the mix of taxable and exempt supplies made.
Where the period of adjustment is reduced so that it aligns with your interest in an asset (see paragraph 6.3), the denominator in the fraction used to determine CGS adjustments also needs to be reduced to ensure that all of the VAT incurred on the asset is reviewed over the period of time that you have an interest in the asset. This helps to ensure a fair recovery of VAT.
Example - a business acquires a 7 year interest in a building that falls within the CGS
One-eighth of total VAT on the capital item would be reviewed at the end of the subsequent 7 intervals.
7.6 How to deal with VAT incurred before the first interval
If you incur VAT before the first interval you’ll need to work out the overall initial percentage you can claim against which you can measure the percentage of taxable use in any subsequent interval.
If you’ve incurred VAT before the first interval you could, for example, work out the percentage of total input tax to which you were originally entitled, by expressing the total input tax recovered as a percentage of the total VAT incurred on the capital item.
A partly exempt business constructs a new headquarters building. It incurs £600,000 of input tax on the building in the tax year ending 31 March 2012. Its partial exemption reclaimable percentage for the year as a whole is 75% so it reclaims £450,000.
In the following tax year, the year ending 31 March 2013, it incurs another £400,000 of input tax on the building and reclaims £320,000 because its partial exemption reclaimable percentage for the year is 80%.
It occupies the building for use in its partly exempt business on 1 September 2012 so the first interval runs from 1 September 2012 to 31 March 2013 (the day before the start of the next tax year, which is 1 April 2013).
The business has therefore incurred some VAT before the first interval and will need to work out an overall average reclaimable percentage to measure against for future subsequent intervals:
Total input tax reclaimed/total VAT incurred x 100% = Average reclaimable percentage
£770,000/£1,000,000 x 100% = 77%
Therefore, 77% is the ‘baseline’ against which future adjustments are measured.
7.7 How to deal with VAT incurred after the first interval
This can happen with construction projects and refurbishments where the work is carried out over a period of time and also where contracts include a retention clause.
If you incur VAT in the first interval, you reclaim it using the normal rules. This is subject to adjustment from the end of the second interval. If you also incur VAT in the second interval, this won’t form part of the CGS adjustment in interval 2, but will be adjusted from the third interval onwards.
There are examples for dealing with these 2 amounts of input tax.
There are 2 options that you may wish to use to deal with input tax incurred on a capital item after the first interval. The 2 options are known as:
- combined adjustments
- parallel adjustments
All the figures in the combined adjustments and parallel adjustments tables are in thousands.
7.8 Example of dealing with VAT incurred after the first interval
This example considers a constructed building which was first occupied for fully business purposes by a partly exempt business on 1 August 2013. At the first interval £8 million input tax was incurred on the capital item of which 75% was recovered using the business’ partial exemption reclaimable percentage. Additional amounts of input tax were incurred in subsequent intervals in completing the construction:
You must work out the amount of adjustment for an interval, you divide the total VAT incurred on the capital item by the total number of intervals in the adjustment period (usually either 5 or 10). You then multiply by the adjustment percentage:
Total VAT on the capital item
Number or intervals in the adjustment period x the adjustment percentage
Combined adjustments (figures in table are in thousands)
This approach involves rolling together the adjustment calculations for the remaining intervals.
Each time an additional amount of VAT is incurred the overall initial recovery percentage, the ‘baseline’, should be re-evaluated and used to measure against for future intervals. The baseline can be calculated by determining what percentage of input tax has been reclaimed over the expired intervals, using the formula:
Input tax reclaimed
VAT incurred x 100% = Average reclaimable %
At the end of interval 2 the business had reclaimed:
£9,600 x 100 = 80%
This becomes the CGS baseline percentage for interval 3.
At the end of interval 3 the business had reclaimed:
£11,850 x 100 = 79%
This becomes the CGS baseline percentage for interval 4.
You should round special method percentages to 2 decimal places. If you’re using the standard method you must round up to the next whole number unless you incur more than £400,000 of residual input tax each month on average in which case you must round to 2 decimal places.
This method produces a net adjustment figure of £45,000 due to HMRC over the 10-year adjustment period.
When deducted from the input tax initially reclaimed of £13,650,000 (over 4 years), the business’ total amount of input tax reclaimed is £13,605,000.
Against total VAT incurred of £17,500,000 this is a reclaimable percentage of 77.74%.
Parallel adjustments (figures in table are in thousands)
This approach involves carrying out separate, but simultaneous adjustments for the remaining intervals of the CGS adjustment period.
This method also produces a net adjustment figure of £45,000 due to HMRC over the 10-year adjustment period.
When deducted from the input tax initially reclaimed of £13,650,000 (over 4 years), the business’ total amount of input tax reclaimed is £13,605,000.
Against total VAT incurred of £17,500,000 this is a reclaimable percentage of 77.74%.
7.9 Changing method
If you do not think your normal partial exemption method gives a fair reflection of how your capital item will be used in making taxable supplies in subsequent intervals you can apply for an alternative CGS method to determine this. Any calculation that achieves a fair result is acceptable. You must obtain HMRC’s agreement before using such an alternative method.
7.10 Choosing the method
It is not always possible for you to choose the method to use. We can insist that you use a particular method to calculate the extent of taxable use of the capital item in subsequent intervals. We’ll only insist on this if we are unable to reach an agreement on the method you should use. We’ll write to you if we think you should use our method. If you do not agree with our decision you can ask for either of the following:
- a review of our decision
- an appeal to be heard by an independent tribunal
There’s more information about what you can do if you disagree with our decision
7.11 Taking account of the partial exemption de minimis limit when calculating CGS adjustments
In any subsequent interval where the longer period calculation finds you to be de minimis any exempt business use in that period is generally ignored for CGS purposes. If, however, the Standard Method Override (See VAT Notice 706: partial exemption) would have been triggered had all the input tax on the item been incurred in the year in question and treated as de minimis, this is not the case.
If we’ve agreed or directed you to use an alternative method for calculating the extent of taxable use of a capital item in subsequent intervals then you should not take account of the partial exemption de minimis limit unless the method specifies otherwise.
In subsequent intervals, you should not include input tax arising from adjustments under the CGS when applying the partial exemption de minimis limit.
You can find out more about the partial exemption de minimis limit in VAT Notice 706: partial exemption. If you have an agreed combined business or non-business and PE method you will not be able to benefit from the de minimis rules.
7.12 If a capital item is not used for a while
Once the CGS has started, even if a capital item is not being used, it’s treated as being used for the purpose for which it’s made available. For example, if you have a computer which you take out of use for repair or overhaul it’s treated, while it’s out of use, as still being used for the same purpose as it was used before the overhaul.
If you dispose of a capital item without ever having used it, see section 9.
8. Accounting for adjustments
8.1 The accounting period used to make the adjustment
You should enter your CGS adjustment amount in your VAT account for the second tax period after the end of the subsequent interval in question. This is the period after the one in which you make your partial exemption annual adjustment for the year (unless you’ve chosen to make your annual adjustment in the last period of your tax year - see VAT Notice 706: partial exemption). You should include the CGS adjustment amount in box 4 of your VAT Return.
For example if:
- your tax periods end on the last day of March, June, September and December, your tax year is the 12 months ending 31 March - you should make your CGS adjustment in the period ending 30 September
- you’re on monthly returns your tax year is the 12 months ending 31 March - you should make your CGS adjustment in the period ending 31 May
- you make payments on account, this wil not effect the timing of your adjustment, which you should make
If your registration is cancelled, you enter the adjustment amount on your final VAT Return for the period ending on the effective date of deregistration.
8.2 Responsibility for carrying out CGS adjustments
The person responsible for accounting for an adjustment for a given interval is the person who is treated as owner at the point immediately prior to the end of that interval. The ‘owner’ of a capital item is a person who has or who acquires an interest in the item in question and will be the person who incurs the VAT charged on the capital item.
8.3 The owner of a capital item following a TOGC
The purchaser is treated as the owner for CGS purposes and is also treated as having done everything that the seller has done in respect of the capital item.
8.4 The owner of a capital item in the case of a VAT group
The representative member is treated as the owner of the capital item for CGS purposes whilst the real owner of the asset is in the representative member’s VAT group. The representative member is also treated as having done everything that a group member has done in respect of the asset.
9. Disposal of capital items during the adjustment period
9.1 Sale of a capital item during an adjustment period
If you sell a capital item before the end of the adjustment period, your adjustment for the interval in which you sell it’ll be your final adjustment for that item and must include all adjustment amounts for any remaining intervals.
To work out the final adjustment:
For the interval in which you sell the item you should work out the adjustment amount (or in the first interval the initial reclaim of input tax) in the normal way as explained in section 7.
For any remaining complete intervals in the adjustment period, the capital item is treated as being used, taxable (at 100%) if the sale was a taxable supply and exempt (0%) if the sale was an exempt supply.
You should make your final disposal adjustment, including all adjustment amounts for remaining complete intervals, on your VAT Return for the second accounting period after the end of the interval in which you sold the capital item. If you have a capital item and the adjustment period ends, see paragraph 6.9.
9.2 How to deal with a transfer of a going concern (TOGC)
If you dispose of a capital item as a transfer of a going concern (TOGC) - see VAT Notice 700/9: transfer of a business as a going concern - you’ll need to give the new owner the details of to the capital item so that future CGS adjustments can be made. As a future new owner you should ask the seller for information on the capital item being sold as a TOGC which relates to the CGS ‘status’. The new owner must continue making the CGS adjustments for any remaining intervals.
9.3 Example 1 of dealing with a TOGC
A fully taxable company constructs a new business premises for £1 million plus VAT. The company recovers the input tax at 100% and uses it as intended in the business for 2 years. In the following year the company decides to let a specific area of the fourth floor. The company does not opt to tax - the supply is exempt. The company is aware of the CGS and makes an appropriate adjustment.
After a further 2 years the company decides to move the taxable operations and sells the building (the building is no longer new) with the benefit of an existing tenant to a VAT-registered property company. This supply is treated as a TOGC. (Neither party has to opt to tax in these circumstances.)
The new owner does not opt to tax and continues to let the premises to the existing and new tenants. The supplies are exempt and during the period covered by the CGS the use has changed from fully taxable to exempt.
The new owner must repay a percentage of the input tax originally claimed by the previous owner. This can be as much as 1/10th for each remaining interval.
9.4 Example 2 of dealing with a TOGC
A hotel chain incurs £3 million plus VAT on a total refurbishment of one of its prestigious hotels. It only makes taxable supplies from the hotel and recovers 100% of the tax incurred. After 5 years the hotel is sold as a TOGC to another hotel chain. Neither party has opted to tax the premises.
The new owners decide that in addition to the normal bed and breakfast, there is a market for supplying conferences and bare room hire. As they have not opted to tax the supplies are exempt - the total income from this venture representing 5% of their turnover.
As the refurbishment is still covered by the scheme the new owner is liable to repay an amount of the original input tax incurred for each of remaining intervals that the item is used in making mixed supplies.
The timing of intervals may change on transfer of the business, depending on whether the new owner of the business is also taking over the seller’s VAT registration number.
9.5 If you’re the seller or new owner of a capital item
If you’re taking over the seller’s VAT registration number then:
- the interval during which the business is transferred continues without a break
- the seller does not need to make any adjustments for that interval
- you, as the new owner are responsible for any adjustments as if you had owned the capital item for the whole of that interval and for any remaining intervals in the normal way
If you are not taking over the seller’s VAT registration number then:
- if you’re the owner:
- the interval in which the seller transfers the business ends on the day before the transfer takes place
each subsequent interval then ends on successive anniversaries of that date irrespective of whether there are any future transfers of the item
- if you’re the seller:
- you should make any adjustment for that interval on your VAT Teturn for the second period after the end of your tax year in the normal way
- if you’re cancelling your registration you should make any adjustment on your final return
- the new owner is responsible for the next interval which runs from the date of transfer to the anniversary date and any other remaining intervals which run for 12 months from each anniversary date
Subsequent intervals applicable to the transferred item may coincide with the new owner’s partial exemption tax year. If they do not, the new owner (who has to carry out successive anniversary adjustments) will need to agree a way of calculating subsequent intervals with HMRC.
Where you transfer a business as a going concern, you do not treat any capital item included as part of the transfer as ‘sold’ for the purposes of the scheme.
9.6 Cancelling your registration
If you are cancelling your registration, you may have to account for VAT on some of your business assets on hand depending on why you are cancelling your registration and what happened when you obtained them. If, when you cancel your registration, you have a capital item covered by the scheme which is still within its adjustment period and you find that you must account for VAT on your business assets, you’ll need to make a final adjustment.
If you are not required to account for VAT on your business assets because the VAT on the supply would be less than the monetary limit specified in VAT Notice 700/11: cancelling your registration, you’ll still be treated as having made a supply and you’ll need to make a final adjustment. This also applies if the supply was exempt or zero-rated.
You should make your adjustment in exactly the same way as in paragraph 9.1, except that you include any adjustment for the remainder of the adjustment period on your final VAT Return.
9.7 If you sell a capital item without ever having used it
If you have never used the item in the course or furtherance of your business, it is not regarded as a capital item for the purposes of the scheme.
If you’ve a capital item, which has not been used for a while, see paragraph 7.12.
9.8 If a capital item is lost, stolen or destroyed
If a capital item is lost, stolen or destroyed you should check your records to see how much the item was used in the interval in which this occurred. Calculate the CGS adjustment as if you had used the item for the whole of that interval. This is your final adjustment for the item. You do not need to make any adjustments for remaining complete intervals in the adjustment period.
You should make your final adjustment on your VAT Return for the second accounting period after the end of the tax year in which the item was lost, stolen or destroyed.
You’ll need to keep all documents which relate to the loss or destruction in case our officers wish to see them.
10. Part disposals of CGS items
10.1 How to deal with part disposals
Before 1 January 2011 the CGS period of adjustment was only brought to an end when the owner disposed of the whole of its interest in the asset. So, for example, if part of your refurbishment was destroyed or part of your building was sold, you would in theory still have been required to perform CGS adjustments on all of the VAT incurred on the asset including that part that had been destroyed. With effect from 1 January 2011 a business that makes a part disposal carries out a final adjustment in relation to the VAT on the part disposal and is only required to carry out adjustments in relation to that part of the capital item still in existence or which it still owns.
If you make a part disposal of an asset you’ll be required to carry out a final adjustment in relation to the VAT incurred on that part of the asset that’s sold or destroyed. If the sale is a taxable supply, that part of the VAT will be attributable to taxable supplies for each remaining complete interval. If the sale is an exempt supply, that part of the VAT will be attributable to exempt supplies for each remaining complete interval. The remaining part of the VAT on the asset that’s retained by you’ll continue to be subject to adjustments in the normal way.
10.2 How the amount of VAT relating to a part disposal is established
The VAT attributable to the part disposal should be calculated on a fair basis. For example, where part of a building is sold, the VAT relating to the part disposal might be determined by reference to the market value of the part of the building sold as a proportion of the total market value of the building. Alternatively, it might be determined by reference to amount of the floor space sold as a proportion of the total floor space of the building. As long as the proportion of VAT attributable to the part disposal is fair, it won’t be challenged by HMRC.
A business acquires a building for £1,000,000 + £200,000 VAT and first uses it on 1 April 2011. It uses the building for exempt purposes until 31 March 2016. It then decides to sell 50% (by floor area) of the building on 30 September 2016 by way of a taxable supply for £750,000 + £150,000 VAT. It retains the remaining 50% of the building and continues to use it to make exempt supplies.
When the business first acquires the building, it intends using it to make exempt supplies and so none of the £200,000 VAT on the purchase is deductible. Therefore the CGS baseline recovery percentage is nil. As use does not change during the following 4 intervals, no adjustment is due. However, in interval 6 it disposes of 50% of the building and this is considered by the business to be a fair reflection of the VAT attributable to that part disposal that is, £100,000.
In interval 6, which runs from 1 April 2016 to 31 March 2017, the business uses the building to make a taxable supply (the part disposal) and for exempt purposes. Therefore the total VAT on the building falls to be residual. If we assume that the partial exemption recovery percentage for this part of the business is 25%, it can recover £200,000/10 × (25% - 0%) = £5,000 in this interval.
For the remaining 4 intervals, the VAT on the part disposal (£100,000) is treated as relating to taxable supplies. Therefore, a final adjustment of £100,000/10 (100% - 0%) × 4 = £40,000 is due to the business.
The business is required to account for output tax of £150,000 to HMRC on the part disposal in 2016. Both the interval 6 adjustment and the final adjustment for the part of the building disposed of are claimable on the second return after the end of interval 6 (that is, in the period ending 30 September 2017).
The business also needs to carry out adjustments in relation to the part of the capital item that it retains. Assuming it continues to be used to make exempt supplies for the remaining 4 intervals, no adjustments will be due.
10.3 How the part disposal by TOGC, loss or destruction is dealt with
In these circumstances, there is no supply for VAT purposes and so no final adjustment is made for remaining complete intervals in relation to the VAT on the part of the capital item that’s been transferred, lost or destroyed. However, adjustments are still required in relation to that part of the capital item that’s retained in accordance with the normal rules (even if related expenditure on the asset falls below the CGS threshold).
If the part disposal is by TOGC the capital item is split into 2 parts and adjustments in relation to the element transferred are continued by the transferee.
11. Other rules on disposals
If you dispose of a capital item before the end of its adjustment period we may apply the disposal test. The disposal test has been updated to deal with part disposals.
11.1 How the disposal test works
The test compares the total input tax recovered in relation to the capital item with the output tax chargeable on its disposal. The total input tax recovered is the aggregate of:
- the input tax initially recovered on the capital item
- any adjustments already made under the CGS
- any final adjustment that’s required as a result of the sale of the item
If the total input tax exceeds the output tax due on the disposal of the item then, in principle, it may be necessary to adjust the amount of input tax recovered in relation to the capital item.
11.2 When the disposal test applies
The disposal test will only apply if you sell a capital item before the end of the adjustment period. You must also have benefited from an unjustified tax advantage because of the early sale. An unjustified tax advantage is normally one arising from an avoidance scheme. The owner would seek to secure an amount of input tax that would still be subject to adjustment under the CGS, were it not for the sale of the item, less any output tax due on the sale.
We have the discretion to exclude certain disposals from the test and therefore from any disposal test adjustment.
For example, it will not be applied:
- to sales of computer equipment
- where an owner disposes of an item at a loss due to market conditions (such as a general downturn in property prices)
- where the value of the item has depreciated
- where the value of the item is reduced for other legitimate reasons (such as accepting a lower price to effect a quick sale)
- where the amount of output tax on disposal is less than the total input tax claimed only due to a reduction in the VAT rate
- where the item is used only for taxable (including zero-rated) purposes throughout the adjustment period (which includes the final disposal)
11.3 The disposal test adjustment
In cases where you gain an unjustified tax advantage you’ll need to calculate the amount of tax to be adjusted. To do this you’ll have to calculate the:
- net tax advantage
- net tax advantage that’s unjustified
Some form of apportionment needs to be applied to work out how much of the net tax advantage is unjustified. This might be achieved using the ratio that the value of the final taxable sale bears to the value of both the exempt supply and the final taxable sale (refer to example 4 in the Statement of Practice).
12. Movements of capital items into and out of VAT groups
12.1 Item moves with a company
When a capital item is moved with a company into or out of a VAT group, the responsibility for the capital item is transferred. This means that the new owner must continue making the CGS adjustments for any remaining intervals.
12.2 Owner of a capital item moves into a VAT group
If you’re the owner of a capital item and you move into a VAT group, the relevant interval terminates a day before the move takes place.
Each subsequent interval will end on successive anniversaries of that date, irrespective of whether there are any future movements into or out of VAT groups.
12.3 Company leaves a VAT group taking capital item bought during group membership with it
If a capital item is obtained by a company while it’s a member of a VAT group and the company moves out of the group, the relevant interval terminates on the day the move takes place. Each subsequent interval shall end on successive anniversaries of that date, again irrespective of whether there are any future movements into or out of VAT groups.
The previous owner of the capital item should make any adjustment for that interval on the VAT Return for the second period after the end of the tax year in the normal way. The new owner then becomes responsible for the next interval, which runs from the date of the transfer to the anniversary date and any other remaining intervals, which run for 12 months from each anniversary date.
Subsequent intervals applicable to the transferred item may coincide with the new owner’s partial exemption tax year. However, if they do not, the new owner (who has to carry out successive anniversary adjustments) will need to agree a way of calculating subsequent intervals with HMRC.
13. VAT incurred before registration
13.1 How the present legislation works
The present legislation applies if you register, or apply to register, on or after 1 January 2011 - even in cases where registration is backdated to an earlier date.
Under the present legislation, expenditure incurred on assets of a description falling within the CGS by an unregistered business counts towards the CGS threshold. If the threshold is met, the related VAT is brought into the CGS.
When you register for VAT, you deduct one complete interval from the period of adjustment (normally 10 years for land and buildings) for each complete year (12-month period) that’s elapsed between the date of first use of the asset (see paragraph 11.3) and the date of registration.
VAT that you incurred on the asset while you were unregistered is non-deductible and so the baseline recovery percentage for the CGS is nil.
The first interval applicable to the asset will run from the date of first use (see paragraph 11.3) to the day before the start of your first tax year (that is, finishing at the same time as the registration period - see VAT Notice 706: partial exemption). The legislation treats this as a subsequent interval and so any taxable use of the asset during the registration period will enable you to make an adjustment in your favour. Because pre-registration use is accounted for by a (potential) decrease in the number of intervals, only use in the registration period needs to be taken into account in considering the first interval adjustment. You then need to monitor taxable use over remaining subsequent intervals, making adjustments in the normal way.
A business purchased a building while it was unregistered for £250,000 and incurred VAT of £50,000 (assuming a 20% rate of VAT for simplicity). It first used the building on 1 October 2009. On 1 January 2011, it registers for VAT and its first tax year starts on 1 April 2011. It uses the building entirely for making taxable supplies after it registers for VAT.
The CGS period of adjustment for the building is ten intervals and the baseline recovery percentage is nil. However, as 1 complete year has elapsed between first use of the building and the date the business registered for VAT, the CGS period of adjustment is reduced by 1 to 9 intervals. The first interval runs from 1 October 2009 to the day before the business’s first VAT tax year which, in this example, is 31 March 2011. As the legislation treats this interval as a subsequent interval, the business needs to establish the recovery percentage for its first interval.
As the business only makes taxable supplies in the first interval, it’s entitled to recover 100% of £50,000/10 = £5,000 in relation to the first interval. The definition of the first interval covers all the way back from first use but this simply sets the CGS running. As exempt pre-registration use is reflected by the number of intervals being reduced (in this case from 10 to 9) that use does not need to be taken into account again in the first interval adjustment. So it’s only the use while registered that’s taken into account.
Assuming the building is used entirely for taxable purposes in subsequent intervals, the business will also be entitled to recover 100% of £50,000/10 = £5,000 in respect of the remaining 8 intervals (as the period of adjustment has been reduced to 9 to reflect use of the asset when the business was unregistered).
13.2 Reclaim VAT on capital items under regulation 111
Pre-registration VAT incurred on Capital items can only be deducted in accordance with the CGS rules and cannot be reclaimed under regulation 111. This is to prevent duplicate claims.
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