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VAT Voice by Steve Allen

Steve Allen, Director of VAT Solutions (UK) Ltd, outlines a potential VAT pitfall for taxable businesses on the sale of premises.It’s a common scenario; a fully taxable business purchases premises from which to conduct its business, and is charged VAT on the purchase. The business claims back the VAT, and after five years of steady growth, it decides to move to bigger premises. It sells its existing property, and thinks no further about the VAT position.

A VAT problem can be created by what is known as the Capital Goods Scheme (‘CGS’). The legislation covering the CGS is contained in Regulations 112 –116 of the VAT (General Regulations), SI 1995/2518. The CGS is a method whereby HM Customs & Excise can make sure the VAT claimed on the purchase of certain capital items accurately reflects the taxable use to which they are put over a period of time – in the case of land and buildings, the period is ten years. In other words, if the ‘capital item’ is put to an exempt use, HM Customs & Excise can ask for some of the VAT back! The CGS mainly effects partly exempt businesses (ones that make both taxable and exempt supplies) but can have an unexpected impact on what are normally fully taxable businesses.

What is covered by the capital goods scheme?

The main types of building covered by the capital goods scheme are:

• the purchase or lease of land or buildings where the ‘consideration’ is more than £250,000 excluding VAT, and VAT has been reclaimed (a ‘new’ or opted commercial property, for example);

• a building that has been altered or extended, where the floor area is increased by 10% or more, and the VAT exclusive costs is more than £250,000; and

• a building where the refurbishment or fitting out costs come to more than £250,000, excluding VAT.

How does it effect a normally fully taxable business?

Using a simple example; a business buys a property for £500,000 plus VAT of £87,500 and uses the building to make parts for the motor industry. It is fully taxable, so it correctly claims all the VAT back on its VAT return. After five years, it sells the building, not have given the slightest consideration to the VAT position. It has not opted to tax the building, thereby making the sale an exempt supply, and has not made a CGS adjustment to the input tax previously claimed. A couple of years later, HM Customs & Excise come along for a routine VAT inspection, and spot the error. As the sale of the building was exempt, and it happened half way through the CGS adjustment period of ten years, HM Customs & Excise will issue an assessment to recover half of the VAT already claimed. The business gets a bill for £43,750 plus interest, and will possibly incur penalties as well.

Under the terms of the CGS, if you sell the building as an exempt supply, the remaining years of the 10-year adjustment period are all considered to be exempt use. So in this example, half of the period was used for taxable activities, and half for exempt use. Consequently, HM Customs & Excise want half the VAT back.

Another more complex example is where a business buys a property for use as offices for £800,000 with no VAT charged. The building is a bit run down, so the new owners undertake a major refurbishment costing £300,000 plus VAT of £52,500. The expenditure is recorded as capital expenditure in the company’s accounts, and because of the refurbishment, the building is now considered to be a capital item. Although the business was not charged VAT on the purchase of the building, the refurbishment cost more than £250,000 plus VAT, thereby bringing the building within the CGS.

Two years after the completion of the refurbishment, the owner of the business decides to sell the building to his ‘pension fund’, and never gives any consideration to the VAT position. He will again be making an exempt supply, only this time, HM Customs & Excise will want 8/10ths of the VAT back, as the building was used for taxable purposes for only two years after the refurbishment. If he sold it after two years he would find himself with a bill for £42,000 (£52,500 x 8/10).

Avoiding the problem

This situation can be easily avoided. However, if you do not take appropriate action before the sale, unfortunately, there will be nothing you can do to rectify the situation once the sale has gone through.

Provided you are aware of the situation, or take professional advice before making the sale, you can solve this problem easily. The main thing is to be aware of it in the first place. Any business that owns a commercial property can opt to tax (i.e. charge VAT) on supplies they make of it. In the case of normal commercial properties used for a business’s own taxable activities, it is not normally necessary to opt to tax it. It is only necessary if the building is a capital item (and most will be these days) and you intend to sell the freehold, or rent it out. If you opt to tax at this stage you change an exempt supply into a taxable supply. In the examples above, the remaining periods of the CGS adjustment period become fully taxable, and there is no clawback of previously claimed input tax under the CGS. In other words, you will not have to pay any money back to HM Customs & Excise.

If you are planning to sell any commercial property that fits into the examples given above, you should opt to tax before you sell. Customs will need to be notified in writing within 30 days of making the option.

March 2005

Steve Allen
Director, VAT Solutions (UK) Ltd
Email: steveallen@vatsolutions-uk.com

VAT Solutions (UK) Ltd
11 Winmarleigh Street,
Warrington,
WA1 1NB

(T) 01925 242497
(F) 01925 242498
(M) 07810 433927
(W) www.vatsolutions-uk.com

VAT Solutions (UK) Limited is an established independent firm of Chartered Tax Advisers, formed by Andrew Needham and Steve Allen. The company has a cross-section of clients from multi-national companies through to medium-sized and numerous smaller regional firms of accountants and solicitors. They produce a regular publication 'VAT Voice', which can be downloaded directly from the Internet via the following address: www.vatsolutions-uk.com/newsletter.doc