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The capital goods scheme is one of the most misunderstood areas of VAT for property businesses. It catches out businesses that have never dealt with it before, and it surprises even experienced operators when a refurbishment or sale triggers an obligation they did not see coming. Our tax advisors at Tax Accountant work with property businesses, landlords and commercial operators on VAT compliance and planning. The capital goods scheme comes up more often than most clients expect — and the cost of getting it wrong can be substantial.
What the Capital Goods Scheme Does
The capital goods scheme — known as the CGS — adjusts the amount of VAT a business recovers on certain high-value assets over time. It ties VAT recovery to actual taxable use of the asset rather than fixing it at the point of purchase. If a business’s use of the asset changes after it acquires it, the CGS requires the business to revisit its original VAT recovery and adjust it up or down accordingly.
The scheme works over an adjustment period — ten years for land and buildings, five years for other qualifying assets. Each year within that period, the business carries out an adjustment calculation on the second VAT return following its partial exemption year end. The adjustment reflects whether taxable use of the asset has increased or decreased compared to the original recovery position.
Which Assets Does the Scheme Cover?
The CGS applies to three categories of asset. Land, buildings and civil engineering works qualify where the VAT-inclusive cost exceeds £250,000. Single computers and items of computer equipment qualify where the cost exceeds £50,000. Aircraft, ships, boats and other vessels also qualify at the same £50,000 threshold.
To fall within the scheme, VAT must have been reclaimed on the asset. The scheme covers freehold purchases and lease premiums. It also covers parts of buildings, enlargements, alterations, extensions, annexes and refurbishments — provided the expenditure is treated as capital expenditure rather than revenue. The capital expenditure in question covers everything that forms part of the fabric of the building. It does not cover items merely attached to it, such as furniture or machinery.
Who Does the CGS Affect Most?
The CGS mainly affects two types of business. The first is partly exempt businesses — those that make a mix of taxable and exempt supplies. This includes many landlords, financial services businesses, healthcare providers and charities that also carry out commercial activity. These businesses can only recover a proportion of their input VAT based on their partial exemption calculation. The CGS then adjusts that recovery annually over the adjustment period as the taxable/exempt use ratio changes.
The second type is a fully taxable business that sells or lets a property without opting to tax it. This is where the CGS catches people out most unexpectedly. A business that is entirely VAT-registered and taxable may have reclaimed all the VAT on a commercial property. If it later sells that property as an exempt supply — without opting to tax — it makes an exempt disposal. The CGS then requires it to repay a portion of the VAT it originally reclaimed, in proportion to the remaining years in the adjustment period.
Our VAT and Intrastat returns team sees this issue regularly. A business sells a trading property, does not opt to tax the sale, and receives an unexpected VAT clawback demand. The solution is straightforward: opt to tax the property before the sale completes. This creates a taxable supply, eliminates the CGS clawback, and preserves the original VAT recovery — though it does mean charging VAT on the sale price.
The Refurbishment Trap
The biggest surprise the CGS creates is not always on the original purchase. It often arises on a refurbishment or enlargement that the business did not realise would bring the property within the scheme.
Consider a property purchased without VAT — perhaps because the seller had not opted to tax. Ten years later the business refurbishes the property at a cost of £400,000 plus VAT and reclaims the VAT on that expenditure. That refurbishment now creates a new CGS item. The business enters a fresh ten-year adjustment period on that refurbishment spend, even though the original purchase never fell within the scheme at all.
The position becomes even more complex where a property is already within the CGS and a refurbishment creates a second CGS item. Consider a property purchased for £600,000 plus VAT with the VAT reclaimed. It enters a ten-year adjustment period. After eight years, the business spends £280,000 plus VAT on a refurbishment. The refurbishment creates a new CGS item with its own ten-year adjustment period. The business now has CGS obligations running for a further ten years — extending its effective adjustment period to eighteen years from the original purchase. HMRC’s guidance on the capital goods scheme sets out the technical rules in full.
Annual Adjustment Calculations
The CGS requires the business to carry out an annual adjustment calculation for each CGS item throughout its adjustment period. The calculation compares the taxable use of the asset in the current interval year with the taxable use assumed at the time of the original VAT recovery.
Where taxable use has increased compared to the original position, the business can recover additional VAT. Where taxable use has decreased — for example because the business has started making exempt supplies from the property — the business must repay VAT to HMRC. The calculation feeds into the business’s partial exemption workings and is submitted on the second return after the partial exemption year end.
Missing these calculations is a common error. So is failing to identify that a CGS item exists in the first place, particularly following a refurbishment. Our tax planning and advisory team reviews CGS positions for clients who are acquiring, refurbishing or selling property — often identifying obligations that the client was not aware of before we reviewed the position.
Opting to Tax and How It Interacts With the CGS
The option to tax is one of the most important tools available to property businesses in managing their VAT position. A business that opts to tax a property can reclaim input VAT on costs related to that property and charges VAT on rents and sale proceeds. Without the option to tax, supplies of land and property are generally exempt from VAT, meaning input tax recovery is restricted.
The interaction between the option to tax and the CGS is critical. Where a business has reclaimed VAT on a CGS item and the option to tax is later disapplied — or where the property is sold without the option to tax being in place — an exempt supply arises and the CGS adjustment mechanism requires a repayment of part of the original input tax. Getting the option to tax right before a transaction completes is therefore essential. HMRC’s guidance on opting to tax land and buildings explains the rules and the notification process. The ICAEW has also published useful technical commentary on VAT and property transactions for businesses navigating more complex positions.
How Our Tax Advisors Can Help
The CGS is an area where specialist VAT advice genuinely pays for itself. A missed adjustment calculation, an unrecognised CGS item on a refurbishment, or a property sale completed without the option to tax can each produce a VAT liability that was entirely avoidable with proper planning.
Our team reviews CGS positions as part of our broader VAT and Intrastat returns and specialist tax services work. We identify whether a CGS item exists, calculate the annual adjustment obligations, advise on option to tax decisions before transactions complete and represent clients where HMRC has raised an assessment or opened a VAT investigation.
If you are buying, refurbishing or selling commercial property — or if you are a partly exempt business with capital assets — get in touch with our team before you commit to a transaction. The CGS is much easier to manage when it is identified in advance than when it surfaces as an unexpected liability after the event.