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HMRC internal manual

VAT Partial Exemption Guidance

Other partial Exemption issues: the Capital Goods Scheme (CGS): other areas

Assets falling within the scheme

Where an asset is acquired for resale it is not normally a capital item. But, if the asset is used by the owner before it is sold or the asset is no longer held for sale, the Capital Goods Scheme will apply. For timing purposes the Capital Goods Scheme can be regarded as notionally applying to the asset from the date the owner acquires it in the normal way. In the case of property assets, the owner’s intention may genuinely change for commercial reasons. An adjustment may have to be made in respect of the interval where the status of the asset changes and the subsequent intervals thereafter, but not for the intervals in which the asset was held for resale. This is because the notional adjustment period had started and where a capital item is not being used, it is treated as being used for the purpose for which it is made available.

You should resist claims as to the status or a change in the status where it conflicts with common sense or the accounting treatment adopted by the owner. If you suspect an avoidance scheme, contact the Partial Exemption Team in Policy, for guidance.

Alternatives to the CGS in adjusting input tax

There are no legal alternatives to the CGS for adjusting capital items for changes of use in subsequent intervals. The CGS is the only legal basis for such adjustments. This was confirmed in the case of The Trustees for the R&R Pension Fund.

Incorrect initial claims for input tax in the first interval

The ‘baseline’ recovery of input tax on a capital item is the amount that is 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; and
  • if they are outside the capping limits, they cannot be corrected at all.

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. As an overriding consideration, however, 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. An example follows:

A business buys a capital item and recovers 70% of the VAT incurred. More than three years later it is discovered that this deduction is in error and only 30% should have been recovered. This error cannot be corrected as it is capped. In interval 6 the business uses the asset 50% for taxable purposes. Despite the fact that they have already recovered 70% of the input tax on the item they are still entitled to use an adjustment percentage of plus 20% in the interval 6 adjustment.

“Use” and “first use”

The terms “use” and “first use” come up in the regulations and there is often confusion between them. This guidance addresses these terms.

| Word | Explanation | || | “Use” | * includes any use in the business; * means the extent to which the input tax is used in making taxable and/or exempt supplies, thus you look at the PE treatment of the input tax to determine use; * can include a grant that will lead to supplies. There is no need to wait for the actual supplies, e.g. rent, which would arise from the grant to constitute “first use” (but see below re input tax.) See East Kent Medical Services - Tribunal LON/98/935; * needs to be use by the “owner” of the capital item (i.e. the person who incurs the input tax, not the legal owner) - not anyone who may occupy the building under the terms of a lease/license; * can include the purposes for which a capital item is made available during the period of adjustment, but there must be an actual use to trigger “first use” and the start of the CGS. | | “First use” | * usually consists of the granting of a lease/license or physical occupation- whichever use happens first (but see below re. input tax); * will be the first time that any part of a constructed, altered, extended, refurbished or fitted out building is used (but see below re. input tax); * is not triggered by the need for completed work |

Other points to consider:

  • You should look for the first use, which is made of the input tax. Although a relevant use can precede input tax being incurred, the CGS will not start until some (any) input tax is actually incurred. This is because we believe that starting to incur input tax makes the building “in the course of construction” (ref East Kent Medical Services- Tribunal LON/98/935);
  • The input tax can be any input tax that is included in the value of the capital item, see Notice 706/2 Capital Goods Scheme, but remember this will include demolition and other preparatory works such as architects, levelling the land and installing drainage;
  • If a grant (or other relevant use) is made before any input tax is incurred then the first interval, “first use”, will not start until some input tax has been incurred. In these cases, as use has already happened, the CGS will start on the date that the input tax is incurred (as that is the point at which we have the 2 essential elements: use and input tax);
  • It is at the point of “first use” that a proper assessment of the value of the supplies made or to be made should be undertaken. If the estimated value is over £250k the work will fall in the scheme and the CGS will start at that point.

Summary: So as long as some input tax has been incurred on relevant supplies, there is a firm intention to build a building (or carry out relevant works to buildings) and that, on a proper assessment the £250k threshold has been or will be exceeded, then this is sufficient to start the CGS. The building does not yet have to have been physically built/altered/refurbished etc.