Authors
Authors
The Government has recently announced an important change to the application of the CGS.
What is the CGS?
The CGS is a VAT adjustment mechanism that ensures that the correct amount of VAT is recovered in relation to the acquisition of certain capital expenditure. This is done by considering the actual use of the capital asset by the business over a certain period (i.e. the recovery of VAT on the acquisition is adjusted depending on whether there have been any changes between taxable and non-taxable use of that asset by the business).
CGS in practice
Historically, there has been a £250,000 threshold (excluding VAT) for capital expenditure where VAT is charged on the acquisition of land and buildings, with a corresponding adjustment period of 10 years. Expenditure includes property improvements, extensions and alterations.
Example:
- Suppose a law firm (A) buys a new office building for £1 million plus VAT. It can typically recover input tax of £200,000 where its supplies of legal services to clients are fully taxable (it will typically be VAT-registered and account for VAT on its legal services to clients in the usual way)
- If A keeps the same level of taxable use of the building, then no corrections are needed in the 10-year adjustment period. However, if in year two, A uses some of the building (eg three of the six floors) for a non-taxable supply (such as letting to an occupational tenant without an option to tax), then a CGS adjustment is needed (as the letting is exempt for VAT)
- The initial VAT recovery is spread over the ten-year adjustment period, so £20,000 per annum here. The new taxable ratio of the building is 50% due to the exempt letting, so A must use this new ratio to calculate the VAT adjustment. This is 50% x the annual ‘share’ of VAT recovery (which is £20,000) = £10,000
- Therefore, A has to pay back to HMRC £10,000 for that second year, and each year for the remaining CGS period if it continues that 50:50 ratio of taxable use of the building. The exercise would need to be done each time there is a change in the ratio of taxable and exempt services in the ten-year adjustment period.
As a result, the scheme prevents businesses from manipulating their level of taxable activity to reclaim more VAT than they are ultimately entitled to.
What are the changes?
The Government has sought to simplify the CGS by announcing the removal of computers from the assets covered by the scheme (which historically had a £50,000 threshold; there has been no word yet on whether ships and aircraft will also be removed from the scope of the CGS). In addition, the capital expenditure threshold of land, buildings and civil engineering work is to be increased to £600,000. The exact time when these changes will come into effect has not been specified (though it is stated to occur ‘in this Parliament’).
Implications
This will reduce the number of capital assets that would fall under the CGS, reducing the administrative burden on businesses. Removing the need for annual CGS calculations on lower value work is particularly helpful for those making relatively small property acquisitions and changes in taxable use. Smaller businesses especially will appreciate not having to dedicate finite resources to dealing with the compliance required and potentially punitive penalties for non-compliance.
However, not everyone will see the benefit. From 1 January 2025, independent schools became subject to VAT on fees. These institutions can benefit from the current regime to the extent that their capital expenditure meets the £250,000 threshold. Depending on the timing, the upcoming increase in the threshold to £600,000 could close off VAT recovery on some future projects. Others may argue that the increased threshold doesn’t go far enough, given that some responses to HMRC’s initial consultation advocated for a £1million threshold.
Clients will need to consider the potential future impact of the CGS on any future capital expenditure. Although the increased threshold may simplify VAT reporting, it could have related VAT accounting implications, such as leading to more applications for VAT partial exemption special methods. Any transitional rules or guidance from HMRC preceding the change will be crucial.
Article by Daniel Onafuwa and Anthony Reeves.
This article is for information purposes only and is not a substitute for tax or legal advice, and should not be relied upon as such. Please contact Anthony Reeves or Cathy Bryant if you have any queries on the above or tax issues generally.