VAT, the capital goods scheme and commercial property costing £250,000 or more

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    Anonymous

    This time, we’re looking at the VAT capital goods scheme.

    There are lots of good reasons for avoiding certain payment points, whether for tax purposes, stamp duty, or simply because of your budget.

    And here’s another one: £250,000. So why?

    It’s because £250,000 is the threshold for the VAT capital goods scheme (“CGS”). And the CGS can cause a lot of hassle.

    If you buy an interest in a property, or carry out certain construction work on a property that you own which costs £250,000 or more net of VAT, then the property concerned, or the work carried out on the property, is subject to the CGS. Work carried out can include extensions, alterations and refurbishments.

    £250,000 seems to be particularly popular when it comes to breweries selling old pubs. And because breweries nearly always opt to tax their properties, it means that a lot of owners of relatively “small” properties end up having to deal with the CGS as and when they sell or develop the properties.

    As I’ll explain, chances are that the CGS won’t cost you anything in these situations, but it’s a hassle and it will make life a lot easier if you ask for the information when you buy the property, or offer £249,999 net instead.

    The CGS is one of the more complicated pieces of VAT legislation.

    Most business owners and professionals are aware of the VAT recovery/partial exemption rules, which dictate whether business can claim VAT on costs or not. The basic principles are as follows:

    • If your business sells goods or services that are liable to VAT at 20%, 5% or the zero-rate then you can, in principle, claim VAT on related costs. If you lease commercial property and opt to tax the property, then your income is liable to VAT at 20% and you can claim VAT on related costs.
    • If your sales are exempt from VAT, then in principle, you can’t claim VAT on related costs. If you lease commercial property and DO NOT opt to tax, then you can’t claim VAT on related costs.

    There are, of course, exceptions to every rule, but these are the most important principles.

    These partial exemption rules are used to calculate how much VAT you can claim each VAT return period. This is followed by an annual adjustment to account for fluctuations to the total VAT incurred at the end of each “VAT year”, which finishes at the end of March, April or May depending on the business’s VAT return periods.

    These same principles apply to business of all sizes, regardless of the value of any properties that they buy to sell or hold as investments. However it’s when the property or value of work done to the property is £250,000 that the CGS kicks in.

    The CGS is a procedure for adjusting how much VAT a business claims on property related expenditure in subsequent years. The scheme also applies to boats, aeroplanes and certain computer equipment valued at £50,000 or more net of VAT, but property is by far the most commonly affected type of expenditure.

    How does it work?

    The scheme requires businesses to adjust how much VAT was originally claimed to reflect change in use between taxable or exempt supplies in future years.

    What does that mean in practice? As I’ll show below, it means that you either have to repay some of the VAT that you claimed on the initial purchase to HMRC, or you may be able to claim MORE VAT from HMRC.

    Example

    First scenario

    Suppose I buy a property in 2010 that costs £300,000 plus VAT of £60,000. I use the property for my taxable business of providing consulting services, so I claimed all of the VAT paid on the purchase.

    In 2014, I decide to move my business and I’ve received a decent offer to lease the property exempt from VAT for 10 years. The tenant is an insurance company making exempt supplies. Therefore from 2014 to 2020, I will use the property to make exempt supplies.

    The CGS applies to properties over 10 years, so my use will break down into two periods:

    • 2010 – 2014: 40% taxable use
    • 2015 – 2020: 60% exempt use

    Under the CGS, I must repay a proportion of the VAT that I claimed on the initial purchase in each year of my exempt use of the property; i.e. £60,000/10 = £6,000. For each VAT year from 2015 – 2010, I must repay £6,000 VAT to HMRC.

    Therefore at the end of the CGS period, my VAT expenditure is as follows:

    • VAT originally claimed: £60,000
    • VAT repaid to HMRC from 2015 – 2020: £6,000 x 6 = £36,000.
    • Total VAT claimed: £60,000 – £36,000 = £24,000.

    Second scenario

    If the situation were reversed and I lease the property exempt from VAT from 2010 to 2014, then used it in my consultancy business from 2015 – 2020, then the VAT expenditure would be:

    • VAT originally claimed: NIL
    • VAT reclaimed from HMRC from 2015 – 2020: £6,000 x 6 = £36,000
    • Total VAT claimed: £36,000.

    You have to do this for each separate property that you own, based on whether the property is used to make taxable or exempt supplies or a mixture of both, for every ten year period. The calculations can be both complicated and time-consuming.

    And these are just the basic principles of the scheme. There are detailed rules about how and when the calculations should be made and how the scheme applies in certain specific situations. HMRC’s guidance is in VAT Notice 706/2: Capital items scheme: http://tinyurl.com/pr5d3sy.

    The messy situations

    There are certain situations that are caught by the CGS that can cause a real hassle.

    Transfer of a business as a going concern

    If you sell a property as a “going concern”, then, in certain situations, the sale is not liable to VAT. It’s not VAT exempt, nor zero-rated, but the transaction isn’t treated as a supply for VAT purposes so VAT must not be charged.

    There are special rules for such transactions, explained in VAT notice 700/9: Transfer of a business as a going concern: http://tinyurl.com/pbwvq45 and VAT Notice 742a: Opting to tax land and buildings: http://tinyurl.com/plsxqmc.

    One of the rules is that the CGS history of the property transfers from vendor to purchaser, which means that the purchaser has to carry out CGS adjustments for the remainder of the vendor’s adjustment period.

    Unfortunately, there’s no easy way of explaining this rule, but it’s easier to show how it works.

    Example

    Let’s consider my original example:

    I buy a property in 2010 that costs £300,000 plus VAT of £60,000. I use the property for my taxable business of providing consulting services, so I claimed all of the VAT paid on the purchase.

    In 2014, I decide to move my business and I’ve received a decent offer to lease the property for the following 10 years. I opt to tax and charge VAT on the rent.

    However, I decide to sell the freehold with the sitting tenant in 2017.

    In this case, I don’t charge VAT on the sale because the purchaser has also opted to tax the property so the sale qualifies as a VAT free “TOGC”. However the purchaser must continue to make the adjustments to the VAT I originally paid for the property until the end of my 10 year adjustment period.

    In practice, it’s unlikely that the purchaser will have to make any adjustments because he has also opted to tax and uses the property to make taxable supplies. However, this isn’t always the case, as I’ve explained below.

    VAT 1614D sales

    A very common scenario caught by the CGS is if you sell an old opted property to a developer who intends to convert or use the property as a dwelling(s) or other residential or charitable charity. In these situations, not only can selling the property exempt from VAT cost you money, but you may also have a CGS liability if you bought the property for £250,000 or more during the previous 10 years.

    Why is this? Well, suppose you buy an office block for £600,000 as a TOGC with sitting tenants. The property itself is about 50 years old, but the previous owners spent £280,000 plus VAT @ £56,000 on extending and refurbishing the property 3 years ago. You and the vendor opted to tax the property, which means that any subsequent sale or lease of the property is liable to VAT at 20%.

    However after 2 years, the existing tenants move out and you’re approached by a developer who wants to buy the empty site with planning permission to convert to flats. He issues a VAT certificate V1614D before you agree the price, which means that you must sell the property to him exempt from VAT.

    Under the normal partial exemption rules, you may not be able to claim VAT on costs relating to the sale or the property itself. However the real cost for you would be the effect of the vendor’s CGS liability. The vendor’s adjustment period has another 5 years to run.

    If you sell the property exempt from VAT, you will have to pay £28,000 VAT to HMRC, which is calculated as follows:
    • Original VAT paid and claimed on extension etc: £56,000
    • Taxable use for leasing to tenants years 1 – 5.
    • Exempt sale in year 6. VAT payable to HMRC is £56,000 x 5/10 = £28,000.

    It’s important to take this into account when you’re calculating your sales price, because you may want to increase the price to take account of the CGS VAT that you have to pay to HMRC.

    And it doesn’t just apply to commercial property…..

    The CGS can also apply to property that is converted to residential or charitable use.

    Let’s consider my original example (again):

    I buy a property in 2010 that costs £300,000 plus VAT of £60,000. I use the property for my taxable business of providing consulting services, so I claimed all of the VAT paid on the purchase.

    After 7 years, I apply for planning permission to convert the property into 2 houses, which I intend to retain as investment properties. In year 8, I lease the newly converted houses to tenants on 6 month rolling leases, which are exempt from VAT.

    In this situation, I would have to repay 10% of the VAT paid on the initial purchase of the property for years 8 – 10 of the adjustment period; i.e. £6,000 x 3 = £18,000.

    And back to our pubs…..

    As you can see, the CGS is a messy subject and can cause a lot of hassle and confusion for all of us – feel free to email me if you see any errors in this article!

    But in the meantime, let’s go back to our pubs. Chances are, if you buy a pub for £250,000, it’s unlikely that the brewery has spent £250,000 on the property in the previous 10 years. The only one time I came across a similar situation is when a brewery sold a pub that was built 8 years previously for just over £220,000 plus VAT and sold it for £250,000 plus VAT to get rid of it. But that’s a very rare situation.

    The frustrating thing is that if you’ve purchased any opted property as a TOGC and you pay £250,000 or more for the property, you have to find out whether the original owner had incurred any expenditure that could be subject to the CGS. So if you’re buying a TOGC, make sure that your solicitor has covered the CGS point so you have the information at hand if you need it in the future.

    Alternatively, offer £249,999 for the property. It will make life just a bit easier in the long run.

    Check out my ebook: “VATWoman’s Guide to VAT and residential property development” a practical guide to help maximize profits for property developers, contractors and professional advisors; for more information about VAT and property transactions.

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