VIT25550 - Is it input tax: current Lennartz users
Change in Lennartz mechanism
Implications
Businesses with goods subject to existing Lennartz mechanism arrangements at 22 January 2010
Changes to Lennartz accounting on 1 January 2011
Businesses with goods subject to existing Lennartz mechanism arrangements on 1 January 2011
Overview of the adjustment mechanism for capital items
If a business has expenditure on goods both before and after 1 January 2011
Businesses who opted to continue using the Lennartz mechanism on 22 January 2010
Clarification of the law – Finance (No. 3) Act 2010 Schedule 8, paragraph 4
How to establish when output tax on non-business use is no longer due
What happens if the records are unavailable?
Calculating whether the Fiscal Balance Point has been exceeded
Change in Lennartz mechanism
Before 22 January 2010 HMRC accepted that the Lennartz mechanism was available where a business asset was put to:
- mixed business and private use; or
- mixed business and non-business use.
However, the CJEU decision in the case of Vereniging Noordelijke Land-en Tuinbouw Organisatie (VNLTO) (see VIT62520) ruled that the Lennartz mechanism cannot be used by a taxpayer who engages in non-business activities that are normal activities of its undertaking. For example, a charity that provides free goods and services that form part of its normal objectives would not be able to use the Lennartz mechanism.
As a result of this judgment it is clear that EU VAT legislation does not give, and has never given, a right to use the Lennartz mechanism in most circumstances where non-business (rather than private) use of the goods creates the deemed Lennartz charge.
Implications
From 22 January 2010, the Lennartz mechanism is only available where:
- the goods are used in part for making supplies in the course of a business activity that give a right to deduct input VAT; and
- the goods are also used in part for the private purposes of the business or its staff, or, exceptionally, for other uses which are wholly outside the purposes of the taxpayer’s enterprise or undertaking.
From this date, where:
- the Lennartz mechanism is not available; and
- goods are used or to be used for both business activities and non-business activities
any VAT incurred must be apportioned between these different activities on the basis of use or intended use.
The VAT attributed to the business activities is input tax. It can be recovered to the extent that the business activities give rise to supplies with a right to input VAT deduction. The VAT attributed to the non-business activities is not input tax and cannot be recovered.
From 1 January 2011 the VAT attributed to the non-business activities is non-business VAT which is initially irrecoverable but which may be subject to adjustment:
- in the annual adjustment if the business has an agreed non-business method under regulation 102ZA, whether stand alone or combined with a partial exemption method;
- under the Capital Goods Scheme (CGS) if it is a CGS item under regulation 113; or
- if payback/clawback under regulations 108 to 110 applies.
HMRC accepted that there may be times where at 22 January 2010 an organisation was committed to using the Lennartz mechanism. This might be because, for example, they had funding in place that was based on the ability to recover upfront all the VAT incurred. So there may be a small number of new Lennartz users after 1 January 2011. However, they should have express permission from HMRC to use the Lennartz mechanism.
Businesses with goods subject to existing Lennartz mechanism arrangements at 22 January 2010
A business may have applied the Lennartz mechanism on the basis of HMRC’s pre 22 January 2010 understanding of the law. If it has, the business could opt to carry on using the Lennartz mechanism for those goods. Businesses who do so must honour the full, ongoing commitment to account for output tax imposed under the Lennartz mechanism under Finance (No 3) Act 2010.
Those businesses that did not exercise this option had to unravel the Lennartz mechanism for goods for which it should, strictly speaking, not have been available by adjusting both their output tax and corresponding input tax.
The final date for accepting this adjustment, even when some periods concerned are capped, was set at 30 June 2011. After this date, HMRC allows businesses to unravel Lennartz only where the original claim is within normal time limits.
Changes to Lennartz accounting on 1 January 2011
Following changes made to European and UK VAT law which came into effect on 1 January 2011 businesses are no longer able to apply the Lennartz mechanism to expenditure incurred in relation to buying, constructing or making:
- immovable property (land, buildings, civil engineering works);
- ships, boats or other vessels; and
- aircraft.
This restriction applies regardless of the mix of activities, for example business and private use, and so for these goods supersedes the 22 January 2010 changes outlined earlier in this section of the manual.
From 1 January 2011 VAT recovery is limited to the extent to which the goods are used to make business supplies that allow associated input tax to be recovered. Like apportionment more generally there is no prescribed method that must be used to determine this proportion. The only rule is that the result must be fair and reasonable.
The changes also required the introduction of an adjustment mechanism to take account any changes in use of the goods over their economic life. The existing Capital Goods Scheme was adapted to cater for this.
After 1 January 2011 the Lennartz mechanism is still available, but only for goods other than those listed above which are used:
- in part for making supplies in the course of a business activity that give a right to deduct input VAT; and
- in part for the private purposes of the business or its staff or, exceptionally, for other uses which are wholly outside the purposes of the taxpayer’s enterprise or undertaking.
Businesses with goods subject to existing Lennartz mechanism arrangements on 1 January 2011
Businesses who had already applied the Lennartz mechanism before 1 January 2011 on goods affected by the changes must continue to use it for those goods. Lennartz charges are based only on the costs incurred before 1 January 2011.
Any VAT incurred on or after this date is recoverable only to the extent that the goods are used to make business supplies with input tax credit.
Overview of the adjustment mechanism for capital items
European law that came into effect on 1 January 2011 meant an adjustment mechanism that would reflect changes in the business use of goods over their economic life had to be introduced. The mechanism had to help ensure a fair recovery of VAT.
To comply with the new law the Capital Goods Scheme (CGS), which prior to 1 January 2011 adjusted for changes in taxable or exempt use of a capital item, was amended.
The mechanism only applies to capital items or parts of capital items acquired after 1 January 2011.
Capital items are:
- land, buildings and civil engineering works, or capital expenditure in relation to those items including construction, refurbishment, fitting out, alteration and extension, where the value is more than £250,000; or
- ships, boats or other vessels and aircraft, or capital expenditure in relation to those items including construction, refurbishment, fitting out, alteration and extension, where the value is more than £50,000.
The CGS adjustment mechanism only applies to capital items that form part of the assets of a business. It is possible to exclude permanently part of or the entire asset if it is not used for business purposes. A business can take the value of the business proportion below the value limits by doing so. This may be attractive if a business does not want the administrative burden of completing the adjustments. See PE Partial Exemption
Recovery of VAT incurred on a capital item is limited to the extent a business uses or intends using an asset for business purposes. The proportion of VAT on the cost of the asset that relates to business activities is input tax. Please note that input tax may be subject to further restriction if the business is partly exempt and uses the asset to make exempt supplies.
The remaining VAT that the business has incurred, referred to as non-business VAT, falls outside of the VAT system. It is never revisited even if business use subsequently increases.
Please be aware that:
- The Capital Goods Scheme applies to all purchases of land, buildings and civil engineering work and capital expenditure in relation to the same including construction, refurbishment, fitting out, alteration and extension, where the value is more than £250,000;
- From 1 January 2011 the Capital Goods Scheme also applies to ships, boats or other vessels and aircraft and capital expenditure in relation to the same including construction, refurbishment, fitting out, alteration and extension, where the value is more than £50,000;
- From 1 January 2011 all of the value and all of the VAT incurred on a capital item that forms part of the assets of a business is included within the adjustment mechanism. Previously the mechanism had been limited to business values only. The only exception to this is where a business elects to permanently exclude the non-business or private part of the capital item from its business. See VIT25240.
- The period of adjustment for immovable property including construction services is normally ten years. For ships, boats or other vessels and for aircraft it is five years.
For further guidance on how to carry out Capital Goods Scheme adjustments see PE Partial Exemption
If a business has expenditure on goods both before and after 1 January 2011
A business may adopt the Lennartz mechanism for expenditure incurred up to 31 December 2010, subject to the applicable rules.
Expenditure incurred on or after 1 January 2011 on immovable property (including construction services that create a building), ships, boats or other vessels and aircraft is not eligible for the Lennartz mechanism. The tax on such expenditure is deductible in so far as it relates to taxable supplies.
An asset and the related VAT will fall within the Capital Goods Scheme (CGS) when the total expenditure exceeds one of the Capital Goods Scheme thresholds. Prior to 1 January 2011, the value of a CGS asset was determined by reference to the business related expenditure. With effect from 1 January 2011 the value is determined by reference to total expenditure on an asset, in other words both business and non-business expenditure on an asset.
When expenditure has been incurred both before and after 1 January 2011 it will be necessary to determine:
- the amount of business related expenditure incurred on the asset up to 31 December 2010; and
- the total amount of expenditure (business and non-business) incurred on or after 1 January 2011.
If the sum of these amounts exceeds the relevant CGS threshold, the asset falls within the CGS.
Businesses who opted to continue using the Lennartz mechanism on 22 January 2010
This section of the guidance applies to businesses that opted to continue to use the Lennartz mechanism where they had entered the arrangement before 22 January 2010. These businesses are required to account for output tax imposed under paragraph 4 of Schedule 8 to the Finance (No 3) Act 2010.
Clarification of the law – Finance (No. 3) Act 2010 Schedule 8, paragraph 4
The purpose of the law is to prevent businesses from being unjustly enriched by ensuring that where input tax has been reclaimed on an asset under the Lennartz agreement, output tax is accounted for on the non-business use of that asset throughout its economic life.
At this point, it is expected that the whole of the cost of the asset would have been taken into account in calculating the output tax due; this ensures that the non-business use of the goods is not excessively taxed.
In 2011, there was an increase in the standard rate of VAT from 17.5% to 20% and the non-business use of some goods may have been excessively taxed. In this circumstance, based on the principles of the legislation, we accept that where the output tax paid equates the input tax originally claimed (the ‘fiscal balance point’) before the end of the economic life of the asset, businesses are not required to continue to account for output tax on the non-business use of the asset.
Businesses whose calculations were impacted by the change in the VAT rate, may want to revisit the sum of output tax they have accounted for under this provision.
How to establish when output tax on non-business use is no longer due
To establish when output tax under the Finance Act (No 3) 2010 {#}ceases to become due, a business will need to collate the following information in order to calculate the Fiscal Balance Point:
- The total sum of non-business input VAT incorrectly credited and retained as input tax as a result of a “Lennartz” election on the acquisition of the asset(s);
- The sum of Capital Goods Scheme (CGS) interval adjustments made on VAT returns in favour of the business which relate to the “Lennartz” assets and the periods in which they were declared;
- Any sums of statutory interest paid by HMRC in respect of delay in crediting any sum at 1;
- A period-by-period total of the output tax brought to account on VAT returns relating to those assets;
- Any sums of output tax assessed by HMRC under Finance Act 2010 and paid by the business, together with details of the period(s) assessed;
- The sum of Capital Goods Scheme interval adjustments made on VAT returns in favour of HMRC which relate to the “Lennartz” assets and the VAT periods in which they were declared.
What happens if the records are unavailable?
Businesses are required to keep their VAT records for 6 years; however, for CGS calculations because the required adjustments could be up to 10 years, these records should have been retained to show each calculated adjustment.
Where records are no longer available because the retention period has expired, the CGS adjustment for the periods in question should be treated as ‘zero’.
Calculating whether the Fiscal Balance Point has been exceeded
The Fiscal Balance Point will have been exceeded if from the 6 points above: the sum of (4 + 5 + 6) exceeds the sum of (1 + 2 + 3).
The amount of the output tax overdeclared and now reclaimable will depend on when the Fiscal Balance Point was first exceeded in a VAT return.
Any claim for repayment of output tax which exceeds the fiscal balance point should be made in writing to HMRC. Generally, a claim must be made within 4 years of the end of the VAT period to which the claim relates
Details of how to make a claim and the time limits which apply can be found in the VAT Notice 700/45 how-to-correct-vat-errors-and-make-adjustments-or-claims