A big VAT rebate currently available to charities could be changing

On the 28 April 2025, the Government announced that it would be making changes to the Capital Goods Scheme (CGS) so charities should give thought as to how this will affect their cash flow and capital project fundraising in the future.

With regard to its most common application, i.e. for land and buildings, the CGS currently applies to VAT-bearing capital expenditure of £250,000 or more (VAT-exclusive) on:

• Acquisition of land, a building or part of a building or civil engineering work.
• Construction of a building or civil engineering work.
• Refurbishment, fit-out, alteration or extension of a building or civil engineering work.

Under the scheme, VAT incurred on “capital items” expenditure is monitored over 10 intervals (typically 10 years in total) by allocating 10% of the total VAT to each interval. If the taxable “use” of the capital item changes compared to the first interval (when the item is first used), adjustments to the amount of VAT initially recovered are required. If the taxable use increases compared to the exempt and/or non-business use, then more VAT is recovered. However, if it decreases, some must be repaid to HMRC.

Expenditure threshold increased

The main change announced in April was that the expenditure threshold for land and buildings is being increased significantly to £600,000 (VAT-exclusive). No date has been given, the Government has just said that it will be “in this parliament”.

While this may generally be welcome news for businesses and some VAT registered charities in terms of reduced administration and, for example, work by lawyers advising on transfers of property which include CGS items, others may question whether the threshold has been increased enough.

The existing threshold of £250,000 has been in place since the scheme was introduced in 1990. Adjusted for inflation, that would be in excess of £700,000 in today’s terms, and notwithstanding that, arguably £250,000 may have been too low a threshold in the first place. And the price of land and buildings generally increases at a rate higher than inflation over a long period. Should the threshold for refurbishments and extensions be higher and should the threshold for acquisitions be higher than that?

Some charities disadvantaged

Considering the impact on charities, however, this measure will not be good news for all concerned. For some charities, where every penny counts, they may be disadvantaged. For example, imagine a charity refurbishing a mixed-use building with a large shop area at a cost of £500,000 plus £100,000 VAT.

Its taxable sales made from the building in year one are low at 10% of total income, but it expects that to increase to 40% in year two and 60% at year 5 of the 10-year CGS period. Under this measure the charity would only achieve a recovery of £10,000 from its initial year’s recovery rate. Whereas, under the current rules, the charity would initially recover £10,000 but then could reclaim a further £34,000 during the 10-year life span.

Looking at the methodology used to recover VAT incurred and seeking agreement with HMRC to use an alternative method to the standard, income-based method may be important for some to consider.

Whilst the impact of this measure could be disadvantageous for charities, as the example above illustrates, it could also be favourable in certain situations. If taxable income and use decreases over time compared to the year in which the VAT is incurred, more VAT will be recovered under the new rules. The critical message for charities, therefore, is to make sure that they understand the impact of these new rules carefully, before works start and really at the time when plans and fundraising requirements are being drawn up.

The CGS is something that many independent schools can consider for the first time following the introduction of VAT on school fees from the start of this year. In a very challenging environment for the sector, a claim under the CGS may provide some additional VAT recovery, if a school has undertaken significant capital works over recent years.

Computer equipment

Although the change to the land and property threshold will be of most interest to charities, there is a further change to the CGS to be aware of. Individual computers and items of computer equipment will be removed from the scheme completely. The scheme currently applies to VAT-exclusive expenditure on computers and such equipment that is £50,000 or more.

The application of the CGS to such items has, as you would expect, been very limited and this is just really tidying up of the legislation. There has been no mention of aircraft or ships in the Government’s announcement so far. Maybe that will “land” (or dock) when more details emerge in draft legislation.

Overall, my view is that despite a proposed increase in the land and buildings CGS threshold, most acquisitions and many refurbishments, alterations and extensions will still be caught. But there remain opportunities to look out for where little or no VAT has been recovered before. For example, with VAT being imposed on private school fees from 1 January 2025, many schools have been registering for VAT for the first time. Several of them will now be able to claim a considerable amount of VAT back on prior and future building projects because of the CGS rules.

The CGS remains complex and maximising recovery of VAT incurred on an asset relies on a thorough analysis of the impact of the rules and the recovery methodologies available. You should seek advice from a VAT specialist on such matters.

PESM applications

Linked with the impact of CGS changes on charity building projects, it is worth noting our experiences of late in respect of Partial Exemption Special Method (PESM) applications made to HMRC. These indicate a concern that there may be a change in HMRC’s approval process which could disadvantage charities.

To explain, a PESM may be used as an alternative to the standard income-based method in order to achieve a fair, usually better, recovery of VAT incurred. PESMs can be used for day to day VAT effectiveness as well as where large amounts of VAT are incurred on capital expenditure, but in each case, they require HMRC’s prior agreement before they can be used.

Until recently, experience was that provided a charity identified a need for a PESM and submitted its application to HMRC before the end of its VAT year end, usually following a lengthy period of due diligence to ensure the proposed PESM was fair, it could adopt that methodology from the start of that VAT year.

In instances where HMRC required further detail on the proposals or decided that aspects of the method may not be fair, they encouraged a period of discussion and negotiation, with the aim of agreeing something that was fair and reasonable to both parties.

Whilst an application may have ultimately led to a rejection of a method if HMRC remained unhappy with the method, instances of rejection as a result of working with HMRC have been limited.

However, more recently one has seen HMRC rejecting out of hand PESM applications, whilst suggesting that a charity may submit a new application that deals with their remarks on the PESM applied for, which can only be applicable to the year in which the new application is made.

Given that it often takes some months for HMRC to respond to a PESM application it has meant that certain charities will have lost out on a year’s worth of fair (improved) VAT recovery, unless of course they are prepared to expend considerable amounts in professional fees in challenging HMRC’s rejection decision.

It is expected that this sort of issue would be raised with HMRC’s policy team in due course, but in the meantime, it is recommended that consideration and submission of a PESM is made as early as possible. Planning ahead is therefore key.