The CGS
If a business acquires or creates a capital asset it may be required to adjust the amount of VAT it reclaims. This mechanism is called the CGS and it requires a business to spread the initial input tax claimed over a number of years. If a business’ taxable use of the asset increases it is permitted to reclaim more of the original VAT and if the proportion of the taxable supplies decreases it will be required to repay some of the input tax initially claimed. The use of the CGS is mandatory.
How the CGS works
Normally, VAT recovery is based on the initial use of an asset at the time of purchase (a one-off claim). The CGS works by applying a longer period during which the initial recovery may be adjusted if there are changes in the use of the asset. Practically, the CGS will only apply in situations where there is exempt or non-business use of the asset. A business using an asset for fully taxable purposes will be covered by the scheme, but it is likely that full recovery up front will be possible with no subsequent adjustments required. This will be the position if, say, a standard rated property is purchased, the option to tax taken, and the building let to a third party. The CGS looks at how capital items have been used in the business over a number of intervals (usually, but not always; years). It adjusts both for taxable versus exempt use and for business versus non business use over the lifetime of the asset. Example; a business buys a yacht that is hired out (business use) and it is also used privately by a director (non-business use). However, a more common example is a business buying a property and occupying it while its trade includes making some exempt supplies.
Which businesses does it affect?
Purchasers of certain commercial property, owners of property who carry out significant refurbishment or carry out civil engineering work, purchasers of computer hardware, aircraft, ships, and other vessels over a certain monetary value who incur VAT on the cost. (As the CGS considers the recovery of input tax, only VAT bearing assets are covered by it).
Assets not covered by the scheme
The CGS does not apply if a business;
- acquires an asset solely for resale
- spends money on assets that it acquired solely for resale
- acquires assets, or spends money on assets that are used solely for non-business purposes.
Limits for capital goods
Included in the CGS are:
- Land, property purchases – £250,000 or over
- Refurbishment or civil engineering works costing £250,000 or over
- Computer hardware costing £50,000 or over (single items, not networks)
- From 2011, aircraft, ships, and other vessels costing £50,000 or more.
Assets below these (net of VAT) limits are excluded from the CGS.
The adjustment periods
- Five intervals for computers
- Five intervals for ships and aircraft
- Ten intervals for all other capital items
Changes in your business circumstances
Certain changes to a business during a CGS period will impact on the treatment of its capital assets. These changes include:
- leaving or joining a VAT group
- cancelling your VAT registration
- buying or selling your business
- transferring a business as a going concern (TOGC)
- selling an asset during the adjustment period
Specific advice should be sought in these circumstances.
Examples
- A retailer purchases a brand new property to carry on its fully taxable business for £1 million plus £200,000 VAT. It is therefore above the CGS limit of £250,000. The business recovers all of the input tax on its next return. It carries on its business for five years, at which time it decides to move to a bigger premises. It rents the building to a third party after moving out without opting to tax. Under the CGS it will, broadly, have to repay £100,000 of the initial input tax claimed. This is because the use in the ten year adjustment period has been 50% taxable (retail sales) for the first five years and 50% exempt (rent of the property for the subsequent five years).
- A company purchases a helicopter for £150,000 plus VAT of £30,000. It uses the aircraft 40% of the time for hiring to third parties (taxable) and 60% for the private use of the director (non-business). The company reclaims input tax of £12,000 on its next return. Subsequently, at the next interval, taxable use increases to 50%. It may then make an adjustment to increase the original claim: VAT on the purchase £30,000 divided by the number of adjustment periods for the asset (five) and then adjusting the result for the increase in business use: £30,000 / 5 = 6000 50% – 40% = £600 additional claim
Danger areas
- Overlooking CGS at time of purchase or the onset of building works
- Not recognising a change of use
- Selling CGS as part of a TOGC
- Failing to make required CGS adjustments at the appropriate time
- Overlooking the option to tax when renting or selling a CGS property asset
- Sale during adjustment period (not a TOGC)
- Complexities re; first period adjustments and pre-VAT registration matters
- Interaction between CGS and partial exemption calculations
Summary
There is a lot of misunderstanding about the CGS and in certain circumstances it can produce complexity and increased record keeping requirements. There are also a lot of situations where overlooking the impact of the CGS or applying the rules incorrectly can be very costly. However, it does produce a fairer result than a once and for all claim, and when its subtleties are understood, it quite often provides a helpful planning tool.