What is the Capital Goods Scheme (CGS)?

The CGS was introduced in 1990 to ensure that large amounts of VAT incurred on capital expenditure in relation to land and buildings would be recovered according to the extent of their taxable business use over the life of the asset. This meant in practice looking at use over a period of 10 years. Computers, aircraft and boats were added in 2011 which are looked at over 5 years. The CGS adjusts for both exempt as well as non-business use.

What does the CGS apply to?

With regard to its most common application, i.e. for land and buildings, the CGS currently applies to VAT-bearing capital expenditure of £250,000 or more (VAT-exclusive) on the:

Acquisition of land, a building or part of a building or civil engineering work

Construction of a building or civil engineering work

Refurbishment, fit-out, alteration or extension of a building or civil engineering work.

Under the scheme, VAT incurred on ‘capital items’ expenditure is monitored over 10 intervals (about 10 years in total usually) by allocating 10% of the total VAT to each interval. If the taxable ‘use’ of the capital item changes compared to the first interval (when the item is first used), adjustments to the amount of VAT initially recovered are required. If the taxable use increases compared to the exempt and / or non-business use, then more VAT is recovered, however, if it decreases, then some must be repaid to HMRC.

What are the implications of the announced changes to the Capital Goods Scheme?

While this may generally be welcome news for businesses in terms of reduced administration and, for example, work by lawyers advising on transfers of property which include CGS items, others may question whether the threshold has been increased enough. The existing threshold of £250,000 has been in place since the scheme was introduced in 1990. Adjusted for inflation, that would be in excess of £700,000 in today’s terms, and notwithstanding that, arguably £250,000 may have been too low a threshold in the first place. And the price of land and buildings generally increases at a rate higher than inflation over a long period of time. Should the threshold for refurbishments and extensions be higher and should the threshold for acquisitions be higher than that?

This measure will not be good news for all concerned, however. Organisations such as charities, where every penny counts, may be disadvantaged. For example, imagine a charity refurbishing a mixed-use building with a large shop area at a cost of £500,000 plus £100,000 VAT. Its taxable sales made from the building in year one are low at 10% of total income, but it expects that to increase to 40% in year two and 60% at year 5 of the 10-year CGS period. Under this measure the charity would achieve a recovery of £10,000 and that would be it. Whereas, under the current rules the charity would initially recover £10,000 but then could reclaim a further £34,000 during the 10-year life span. Looking at the methodology used to recover VAT incurred and seeking agreement with HMRC to use an alternative method to the standard, income based, method may be important for some to consider. This can work both ways of course. If taxable use decreases over time compared to the year in which the VAT is incurred, more VAT will be recovered under the new rules.

Additional announced changes to the CGS

The other main change announced to the CGS is that individual computers and items of computer equipment will be removed from the scheme completely. It currently applies to VAT-exclusive expenditure of £50,000 or more. The application of the CGS to computers has been limited and this is just really tidying up the legislation. There has been no mention of aircraft and ships as yet. Maybe that will ‘land’ (or dock) when we see more detail in draft legislation.

Overall, our view is that despite a proposed increase in the land and buildings CGS threshold, most acquisitions and many refurbishments, alterations and extensions will still be caught. But there remain opportunities to look out for where little or no VAT has been recovered before. For example, with VAT being imposed on private school fees from 1 January 2025, we have been helping many schools register for VAT for the first time. Several of them will now be able to claim a considerable amount of VAT back on prior and future building projects because of the CGS rules. The CGS remains complex and maximising recovery of VAT initially on an asset may rely on a thorough analysis of recovery methodologies.