Changes to VAT recovery on fixed assets

What is CGS?

Where goods and services are used for activities that are both taxable (including zero-rated) and exempt from VAT, this VAT is partly recoverable. For most expenditure, the VAT recoverable is calculated in the period it is incurred; and then it is recalculated after the VAT year end when the annual adjustment is prepared. Similar rules apply where there is some non-business use of the item.

However, for certain capital expenditure, this VAT recovery needs to be considered over approximately ten years. If the business’s use of the asset changes, in subsequent periods so that it can recover a higher or lower percentage of such VAT, there is an adjustment required.

The items to which this requirement calculation currently applies are:

• a computer or a single item of computer equipment
• an aircraft, including an air ambulance
• a ship, boat, or other vessel, including a yacht
• property expenditure, including acquiring land, constructing a building, or refurbishing an existing building
• civil engineering works.

For the first three categories, capital expenditure of £50,000 + VAT or more needs to be considered. For property expenditure and civil engineering work, it is £250,000 + VAT. The rules only apply to the VAT-bearing expenditure, so most residential buildings and passenger transport are not caught by these rules.

It is a common misconception that the CGS only applies to ‘partly exempt’ organisations, this is not the case, and all organisations should be aware that they may need to keep CGS records, even if they are ‘fully taxable.

Examples of how this applies in practice

A housing association refurbished its head office in 2023/2024 at a cost of £300,000, plus £60,000 of VAT. It was able to recover 10% of its VAT on overheads that year and so recovered £6,000 of this VAT. In 2024/2025, its recovery rate dropped to 8%. It is required to prepare a complex calculation of its VAT recovery entitlement, which results in the organisation repaying £120 to HMRC.

A manufacturing business incurs £1,000,000 plus £200,000 of VAT building a new warehouse. It is able to recover 100% of this VAT. Eight years later, it no longer needs this facility as it sells it to a property developer without opting to tax, an exempt sale. It is required to repay £40,000 to HMRC.

Two years ago, a private school incurred £1,000,000 plus VAT of £200,000, building a new swimming pool.  At the time, it was not registered for VAT, and so no VAT was recovered. Since January 2025, it has been required to charge VAT on its fees and is now able to reclaim most of this capital expenditure over the next seven or eight years.

What are the issues at present?

CGS calculations are complex, time-consuming, and easy to miss entirely for a business that normally has just one type of VAT treatment. 

The thresholds for when CGS applies have not been changed since 1990 and has resulted in an increasing amount of organisations having to do calculations like the first example above, where an adjustment in three figures is required.

Meanwhile, prices of computers have decreased, and it is very rare to see an IT cost that falls within these rules. However, property prices and construction costs have often outpaced general inflation.

What are the changes proposed?

The government proposes to remove computers and computer equipment from the list of items to which these rules apply.

It is proposed that the threshold for land, buildings, and civil engineering works will increase to £600,000. This is less than an inflationary increase would have been, but it should still be generally welcomed as it excludes some refurbishment programmes and smaller building projects from the scheme.

There is no mention of ships and aircraft, so organisations such as air ambulance trusts and yacht charter businesses, who need to monitor these calculations, appear to be continuing with their current rules.

When will these changes be effective?

The government has not yet provided an effective date for these changes, however, it will be a later date within this Parliament. We anticipate that these changes will apply to new fixed assets created after the effective date, so any businesses with an existing fixed asset that falls within the capital goods scheme will need to continue to make adjustments if the VAT recoverability on this item alters during the 10 year adjustment period.

For more information, please get in touch with Adam Cutler or your usual VAT contact.