The requirement to make adjustments to the deduction of input tax on capital items, more commonly known as the capital goods scheme, was introduced with effect from 1 April 19901. The scheme was introduced in response to concerns that certain traders were recovering input tax in circumstances where the goods on which the input tax was incurred were not, in the long term, being used in a fully taxable business. For example, a person making only taxable supplies but who was planning to make exempt supplies might purchase computers and obtain credit for the whole of the VAT incurred in a year in which he only made taxable supplies, even if he subsequently used those computers in his exempt business. The same situation could arise inadvertently, for example where a trader purchased a computer intending to use it only in a fully taxable business but later expanded his business to include exempt supplies.
The scheme was extended in relation to capital items obtained on or after 1 January 2011 to bring additional items within the scope of the scheme, and to allow for adjustments in respect of fluctuations to the extent to which such items are used for business/non-business purposes2.
The capital goods scheme is mandatory under art 187 of Directive 2006/112/EC3. For HMRC's views on the operation of the scheme, see Notice 706/2/184.