Input tax/Capital Goods Scheme in a nutshell
Input tax is the VAT which a VAT-registered business incurs on purchases (stock, overheads, capital assets) and which it uses for business purposes. If the business makes only taxable supplies, it can recover all its input tax (with certain exceptions). If the business makes only exempt supplies, it cannot recover any of its input tax (and usually will not be VAT registered); if it makes both taxable and exempt supplies, it is partly exempt and can only recover the input tax attributable to taxable supplies.
In the case of capital goods, it is possible that the use to which the goods are put may vary between taxable and exempt (and possibly non-business) over a period of time. The Capital Goods Scheme enables/requires a taxpayer to make adjustments to the original input tax recovery to reflect any variation over a five or ten-year period (depending on the nature of the goods) where the capital goods are of significant value.
What are capital goods?
Computers, aircraft, ships, boats and other vessels with a value of not less than £50,000 (five-year period of adjustment)
Land, buildings and civil engineering works with a value of not less that £250,000 (ten-year period of adjustment)
How does the Capital Goods Scheme work?
The initial recovery of input tax on a capital item is based on the taxpayer’s recovery rate at the time the capital item is acquired. Where that recovery rate changes in a subsequent tax year within the five- or ten-year adjustment period, an adjustment is made to reflect that change.
- X Ltd purchases a commercial property for £500,000 plus £100,000 VAT. X is partly exempt and, at the time of purchase, is entitled to recover 80% of its input tax. It therefore claims £80,000 as input tax.
- In the following year, X’s recovery rate increases by 5% to 85%. It is therefore entitled to claim a further 5% of one-tenth (since there is a ten-year adjustment period) of the VAT incurred on the building, ie £500.
- In the next year, X’s recovery rate decreases by 10% (compared to the initial recovery rate) to 70%. It must therefore repay to HMRC 10% of one-tenth of the VAT initially incurred, ie £1000.
- Further adjustments are made, if necessary, over the remainder of the ten year period after which no further adjustments are required.
- Special arrangements are in place where the capital item is disposed of during the period of adjustment.
- Anti-avoidance rules are in place to prevent manipulation of the Capital Goods Scheme.