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Phased developments - Capital Goods Scheme and Option to Tax

February 2017

Disapplication of the Option to Tax and a ground breaking decision

This case was about the acquisition of a former public house and its conversion in two phases into a ground floor children's nursery and the upper floor to apartments. A lease on commercial terms was granted to an associated company for the ground floor.  Two building contracts were entered into for the conversion work to be done in two distinct phases, one for the alterations to form a nursery and the other for the development of three flats. The ground floor was opted to tax.

Flying in the face of their own policy and public notice on the subject, HMRC considered that that the costs should have been aggregated bringing the project into the Capital Goods Scheme i.e the £250K CGS limit would have been breached. As such the option to tax would have been disapplied under the anti-avoidance provisions of Schedule 10 VATA 1994 - with consequences for input tax recovery.    

The First- tier Tribunal observed however that the Regulations contain no express indication of how the £250,000 threshold is to be applied where expenditure is of more than one of the specified types. The issue was therefore whether the amount of more than one type of expenditure can be aggregated for the purposes of reg 13, and, if so, in what circumstances.

The First-tier Tribunal found that the separation in time between the acquisition and the commencement of the building works and the uncertainties as to the availability of finance, and therefore whether the works would be carried out, meant that there was no capital item to which reg 13 could apply so that the option to tax made by the company was valid (VATA 1994, Sch 10 para 12) and it could recover input tax incurred in relation to the acquisition and refurbishment of the ground floor. 

The First-tier Tribunal said: 'We were surprised that this case came before the Tribunal at all. The taxpayer had relied on the guidance issued by HMRC relating to phasing of developments in paragraph 4.12 in VAT Notice 706/2.'

Perhaps the most interesting point about this case is the judgment of the Tribunal that even though it found that the property was not a capital item, as there was no abuse, HMRC could not have disapplied the option in any event. This a  radical departure  and a notion which will be very bad news for HMRC if it is ever tested in a higher court and found to be correct.

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