Capital Goods Scheme
Deloitte Malta Tax Alert
17 September 2021
The Capital Goods Scheme (CGS) is a mechanism which was introduced to ensure that the input VAT recovered on capital goods reflects the use that those capital goods are put to over their useful life. This is a fundamentally significant part of VAT legislation which, in our experience, often tends to be overlooked or applied incorrectly by businesses, resulting in exposure to significant potential liabilities to VAT, penalties and interest.
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Is this relevant to my business?
Capital goods are defined as: “all tangible fixed assets, which can be used on a long term basis as working tools or other means used for the carrying on of an economic activity.” Construction contracts are also deemed to constitute capital goods. There is a de minimis value threshold of €1,160, such that goods below this value fall outside the scope of the CGS. Capital goods
Is this relevant to my business?
The CGS affects all taxable persons who acquire capital goods, especially those engaged in supplies which do not confer full rights of input VAT recovery – such as real estate developers and lessors – and taxable persons which make use of capital goods for both business and private purposes.
How does it work?
If a business which is eligible to recover input VAT purchases a capital good, the input VAT is recovered upfront. In terms of the CGS, however, adjustments may need to be made to ensure that the amount of input VAT deducted correctly reflects the use of the capital good over its useful life. In this regard, an annual review is carried out by comparing the taxable use of the capital good in the current tax period with the taxable use of the capital good in the period when the input VAT was initially deducted. The CGS is therefore triggered in the event when input VAT is initially claimed on a capital good and subsequently input VAT recovery rights change at any point during the VAT-life of the asset.
For VAT purposes, the life of an asset and hence the corresponding adjustment period for CGS purposes is as follows:
(i) Five (5) years with respect to movable property;
(ii) Twenty (20) years with respect to immovable property.
Types of adjustment
Specific scenarios may trigger either an annual adjustment or a one-time adjustment.
Annual adjustments are triggered where, for example, an entity carries on mixed supplies and its input VAT recovery ratio (calculated using the standard partial attribution, based on a turnover pro rata) varies on an annual basis. Similar to how annual partial attribution adjustments are required to be carried out in relation to other general business overheads, such adjustments would typically be accounted for in the first VAT period of the following year. Therefore, if, for example, during the first quarter of 2021, a laptop computer was acquired and input VAT was recovered applying the provisional partial attribution ratio of 2021 (i.e. based on actual turnover figures for 2020), an adjustment to reflect the actual recovery ratio for 2021 (i.e. based on actual turnover figures for 2021) would need to be accounted for in the first VAT period of 2022. Such adjustments would need to be made annually until the asset’s adjustment period elapses.
On the other hand, one-time adjustments are triggered when, for example, an entity which originally carried on supplies conferring input VAT recovery rights (e.g. VAT taxable supplies) switches its activity to one entailing supplies which do not confer input VAT recover rights (e.g. exempt without credit supplies). Such adjustments would typically be accounted for during the VAT period in which the event triggering the adjustment occurs.
The CGS tends to be complex and is particularly challenging to apply to particular situations in practice. The issues include lack of clarity in certain key provisions within the CGS regulations, the interaction between the CGS and other VAT rules such as transferring a business as a going concern and partial exemption calculations, difficulty in applying the CGS vis-à-vis sale and leaseback transactions, and the effect of VAT Grouping, bankruptcy, liquidation and VAT deregistration.
The CGS is a measure to avoid abuse and unjust enrichment to persons acquiring capital goods. The CGS helpfully acknowledges and confirms the general principle that, in the case of businesses enjoying input VAT recovery rights, an immediate deduction of input VAT incurred is typically allowed. In the event of changes in circumstances, there is either a claw back of part of the initial deduction, or an additional deduction, in order to equitably reflect the actual taxable use of the asset. While this is perfectly sensible, based on our extensive experience of applying the CGS in practice, we are aware that significant complexities may arise, and our law does leave a number of open questions which tends to compound the challenge of applying the CGS correctly.
Should you have any questions regarding how the CGS may impact your business, or require our assistance with applying the CGS correctly to ensure proper compliance and mitigate your VAT risk, please do not hesitate to contact us.