VAT – Simplification of Partial Exemption and the Capital Goods Scheme

A call for evidence, Simplification of Partial Exemption and the Capital Goods Scheme was published on 18 July 2019. The consultation closes on 26 September 2019.

The consultation was announced at Spring Statement 2019 and follows the Office of Tax Simplification’s (OTS) review of VAT which was published in October 2017.

The call for evidence addresses unnecessary complexities that were highlighted by the OTS back in 2017. In the same report, the OTS recommended that the level of the VAT registration threshold is changed. We are yet to see this happen, in spite of the government announcing that the threshold is being reviewed. It therefore is uncertain whether measures to simplify partial exemption and the capital goods scheme will ever be introduced. That said, the simplifications in the call for evidence should be a lot easier for the government to implement than lowering the VAT registration threshold, so it is worth understanding the potential changes so you can identify which of your clients may be affected.

Partial exemption special methods

The overriding premise of the partial exemption calculation is that it allows the partially exempt business to reclaim a “fair and reasonable” amount of input tax. If the standard method (the amount of residual input tax reclaimed is determined by the ratio of taxable sales to exempt sales) does not produce a true and fair result, a special method should be used.

In order to use a special method, the business must submit a proposal to HMRC. The proposal must be signed and should include a statement saying that the method is considered to be fair and reasonable. HMRC then review the method and, ideally, give their approval. Obtaining HMRC approval can take years. The process is burdensome for both HMRC and the taxpayer.

The call for evidence suggests that businesses will no longer have to obtain HMRC approval to use a special method. Instead, sectoral frameworks and guidance written in conjunction with industry representative bodies will be used more widely.

De minimis limits

If a partially exempt business is “de minimis”, it is deemed to be a fully-taxable and is entitled to reclaim all of its input tax.  A business is de minimis if, in a VAT period, its exempt input tax (directly attributable to exempt supplies and the exempt portion of the residual input tax) is not more than:

• £625 per month on average, and
• Half of the total input tax in the period

In 2010, simplified de minimis tests were introduced, meaning it is not necessary for many businesses to perform the full partial exemption calculation:

Test 1 - Total input tax is not more than £625 per month on average, and

              The value of exempt supplies is not more than 50% of the value of total supplies.

Test 2 - Total input tax less the input tax directly attributable to taxable supplies is not more than £625 per month on average, and

              The value of exempt supplies is not more than 50% of the value of total supplies.

If test 1 is met, the business is deemed to be de minimis. If test 1 is not met, the business can apply test 2.

If test 2 is met, the business is deemed to be de minimis. If test 2 is not met, the business can carry out the full calculation and apply the full de minimis test which is given above.

Many felt that these simplified tests actually add complexity to partial exemption, and it is not surprising to hear that few businesses are using them.

The call for evidence asks for views on how the de minimis limits can be simplified. For instance, are there other ways we could use to determine what is considered an “insignificant” level of input tax?

Another suggestion is to increase the de minimis limit. This would be welcomed, as the current £625 per month de minimis limit has not changed since 1994.

A suggested alternative is to remove the de minimis limit altogether. This would mean no input tax could be reclaimed if it related to exempt supplies. It is unlikely that such a measure would be popular.

Capital Goods Scheme (CGS)

The purpose of CGS is to recognise that certain capital items have a long useful life, and it ensures the input tax reclaimed in respect of such an asset reflects the extent to which the asset is put to taxable business use over its lifetime.

The following assets are subject to CGS:

• Land, buildings, alterations, extensions and refurbishments costing over £250,000
• Computers, boats, ships and aircraft costing over £50,000

When the asset is acquired, the input tax reclaimed should reflect the extent to which the asset is put to taxable business use. Over subsequent years, the taxable business use is monitored and a CGS adjustment is calculated. If taxable business use has increased, more input tax is reclaimed; if taxable business use has decreased, input tax is returned to HMRC.  For land and buildings, CGS adjustments are carried out for ten years; for other assets, CGS adjustments are carried out for 5 years. These yearly adjustment periods are known as “intervals”.

The OTS review of VAT quite reasonably described the CGS as burdensome, and pointed out that the monetary limits seem outdated.

The call for evidence asks for views on increasing the monetary threshold for land and buildings. It has been set at £250,000 since 1990 and an increase would remove many businesses from CGS. Respondents are asked whether they feel the threshold should also be increased for extensions and alterations.

Nowadays, computers rarely cost more than £50,000, so the call for evidence asks if respondents feel it would be worthwhile to remove computers from the list of CGS assets.

The call for evidence also asks for opinions on the number of required CGS adjustment intervals; should the number be increased or decreased?  A lower number of intervals would be less burdensome and a higher number could give more scope for errors.

 

Many agree that the OTS were correct in saying that partial exemption and CGS are areas that are needlessly complex and outdated, so it is good that the government is consulting on the issues raised. Hopefully we will see some simplification measures announced in the near future.