When acquiring, constructing or refurbishing commercial property, VAT recovery is often a significant consideration. Businesses may recover substantial amounts of VAT upfront, particularly where a property is intended to be used exclusively for taxable activities.

However, recovering VAT at the outset does not necessarily mean the position is permanently settled.

The VAT Capital Goods Scheme (CGS) requires businesses to monitor the use of certain high-value capital assets over several years. If the extent to which a property is used for taxable activities changes, an adjustment to the VAT originally reclaimed may be required.

For property investors, developers and businesses undertaking significant capital expenditure, understanding the CGS is essential to avoiding unexpected VAT liabilities and ensuring that property transactions are structured appropriately.

What is the VAT Capital Goods Scheme?

The VAT Capital Goods Scheme is designed to ensure that VAT recovery on high-value capital assets reflects their actual use over time.

Under the scheme, businesses review the use of qualifying assets during an adjustment period. Where the proportion of taxable use changes, an adjustment may be required to the VAT initially reclaimed.

The CGS applies to qualifying capital expenditure on land and buildings, including acquisitions, construction, alterations, extensions and certain refurbishments.

Following the increase introduced on 29 July 2026, the scheme applies to qualifying land and buildings with a value of £600,000 or more, excluding VAT, where the expenditure is subject to VAT at the standard or reduced rate.

The scheme also applies to certain aircraft, ships, boats and other vessels with a VAT-exclusive value of £50,000 or more.

What types of property expenditure fall within the CGS?

For land and buildings, qualifying expenditure includes:

• Acquiring an interest in land, a building or part of a building.
• Constructing a building or civil engineering work.
• Alterations, extensions and annexes.
• Capital expenditure on services and goods incurred in refurbishing or fitting out a building, where the expenditure is capitalised for accounting purposes.

When calculating the value of a qualifying building project, relevant costs may include construction works, professional fees, demolition, site clearance, materials, equipment hire, landscaping and fitting out.

Certain fixtures that become part of the building, such as lifts, air conditioning and permanent lighting installations, may also form part of the value of the capital item.

It is therefore important to assess the project as a whole rather than considering individual invoices in isolation.

How long does the CGS adjustment period last?

For buildings and other qualifying capital items, the standard adjustment period is 10 intervals.

The first interval generally begins when the asset is first used. For a building, this may be when it is first occupied, leased or otherwise brought into use, depending on the circumstances.

Subsequent intervals generally align with the business’s partial exemption tax year.

During these intervals, the business must consider whether the extent of taxable use has changed compared with the baseline recovery position.

The adjustment period may be shortened in certain circumstances, including where the business only holds an interest in the asset for a limited period.

How do CGS adjustments work?

The amount of VAT initially reclaimed is used to establish a baseline recovery percentage.

This represents the proportion of VAT on the capital item that was deductible.

During subsequent intervals, the business reviews the extent to which the asset is used for taxable supplies and compares this with the baseline.

If taxable use increases, additional VAT may be recoverable.

If taxable use decreases, some of the VAT previously reclaimed may need to be repaid to HMRC.

The calculation is based on the VAT incurred on the capital item, the number of intervals in the adjustment period and the change in the recovery percentage.

Importantly, the CGS is concerned with changes in the use of the asset, not simply whether the business remains VAT-registered or continues trading.

What does a change in use actually mean?

A change in use occurs when the extent to which a property is used for taxable activities changes.

For example, a building may initially be used entirely for taxable business activities, but later be partly used for exempt activities.

This could arise where:

• A business begins letting part of its premises for exempt rental income.
• A property previously used for taxable activities is converted into residential accommodation.
• A business changes the activities undertaken from a building.
• Part of a commercial property is transferred to another business with different VAT treatment.

The relevant consideration is how the property is used to make taxable, exempt or non-business supplies.

Example: A commercial property with changing use
A company acquires a commercial property for £700,000 plus VAT and recovers all the VAT because it intends to use the property exclusively for taxable business activities.

Several years later, the company decides to let part of the building to a tenant for office use without opting to tax.

Depending on the precise circumstances, the rental income may be exempt from VAT.

The building is now being used for a combination of taxable and exempt activities. This change may require the company to adjust the VAT originally reclaimed under the CGS.

The potential adjustment will depend on the extent of the change in taxable use and the remaining adjustment period.

CGS example: A converted warehouse

Consider a company that acquires a warehouse for £300,000 excluding VAT and undertakes a substantial conversion into a restaurant and events venue.

The company intends to use the property exclusively for taxable activities and recovers the VAT in accordance with the applicable rules.

No change of use
If the company operates the restaurant and events venue throughout the CGS adjustment period, with the property continuing to be used for taxable activities, there may be no CGS adjustments arising from a change in use.

Introducing exempt activities
Suppose the company subsequently decides to rent part of the premises to a business for office use, without opting to tax the rental. The company may now be using part of the property for exempt activities.

An adjustment could be required to reflect the reduced proportion of taxable use, potentially resulting in VAT being repaid to HMRC.

The calculation would depend on the proportion of the property affected, the relevant recovery methodology and the remaining adjustment period.

What if the property is sold?
Selling a capital item during its adjustment period generally triggers a final CGS adjustment. The treatment depends on whether the sale is taxable or exempt.

Where the sale is taxable, the remaining intervals are generally treated as taxable use. Where the sale is exempt, the remaining intervals are generally treated as exempt use.

This can produce a significant adjustment, particularly where substantial VAT was reclaimed on acquisition or development.

What happens when a property is sold?
A property sale during the CGS adjustment period requires careful consideration.

The seller must calculate the adjustment for the interval in which the sale takes place, together with adjustments for the remaining complete intervals.

For example, where a building was acquired and used for taxable activities but is subsequently sold through an exempt transaction, the business may need to repay a proportion of the VAT originally reclaimed.

Conversely, where a sale is taxable, the final adjustment may result in additional VAT recovery.

What about a Transfer of a Going Concern?

A Transfer of a Going Concern (TOGC) is treated differently from an ordinary sale for CGS purposes.

Where a capital item is transferred as part of a qualifying TOGC:

• The purchaser is treated as the owner for CGS purposes.
• The seller must provide the purchaser with relevant CGS information.
• The purchaser assumes responsibility for adjustments for the remaining intervals.

The CGS does not simply end when the property changes hands. This is particularly important in commercial property transactions involving tenanted buildings, property businesses and VAT groups.

Why can the CGS create unexpected VAT liabilities?

1. Unexpected VAT clawbacks
   A business may recover substantial VAT on acquiring or developing a property, only to discover years later that a change in use requires part of that VAT to be repaid. This can create an unexpected cash flow burden.
2. Changes to business activities
   A property initially used for taxable activities may later accommodate exempt lettings, different business divisions or other activities with different VAT treatment. These changes can affect the CGS position even where the original VAT recovery was correct.
3. Property disposals
   Selling a property before the end of the adjustment period can trigger a final adjustment covering the remaining intervals. The VAT treatment of the sale is therefore an important consideration when planning a disposal.
4. Complex record keeping
   Businesses must retain sufficient records to support:
   • The value of the capital item.
   • VAT incurred.
   • VAT initially reclaimed.
   • The methodology used to calculate recovery.
   • The start and end dates of adjustment intervals.
   • Subsequent adjustments.
   • Details of disposals.

Although general VAT records are ordinarily subject to a six-year retention requirement, CGS adjustments may continue for up to 10 years. Businesses should therefore retain relevant records for long enough to support the calculations throughout the adjustment period.

How can businesses avoid CGS problems?

The CGS should be considered at the outset of a property acquisition, development or refurbishment and not only when a VAT adjustment becomes necessary.

Businesses should:

1. Assess whether the expenditure falls within the CGS.
2. Establish the intended taxable and exempt use of the property.
3. Ensure the initial VAT recovery calculation is properly supported.
4. Monitor changes in the property’s use throughout the adjustment period.
5. Review the VAT implications of any proposed letting, restructuring or disposal.
6. Maintain appropriate CGS records and calculations.

For larger projects, it may also be appropriate to consider the VAT treatment of the transaction structure, including whether an option to tax or a TOGC may be relevant.

How we can help

The VAT Capital Goods Scheme can have significant financial implications for businesses acquiring, developing or holding commercial property.

Whether you are purchasing a property, undertaking a major refurbishment, changing the use of existing premises or planning a disposal, early VAT advice can help identify potential risks and avoid unexpected adjustments.

Our tax advisers can assist with:

• Reviewing whether property expenditure falls within the CGS.
• Advising on initial VAT recovery.
• Assessing the VAT implications of proposed changes in use.
• Reviewing CGS adjustments and record-keeping requirements.
• Advising on property disposals, TOGCs and options to tax.
• Supporting businesses with wider VAT planning for property transactions.

If your business is undertaking a significant property transaction or has previously reclaimed VAT on qualifying capital expenditure, contact our team to discuss how the CGS may affect you.