VAT and leasing contracts with an option to purchase

HMRC has published details of its new policy concerning the VAT treatment of “personal contract purchase” arrangements following the 2017 ECJ decision in the Mercedes Benz case.

HMRC has announced a change of policy in relation to the application of VAT to certain financing contracts knows as “personal contract purchases” (PCPs). Revenue & Customs Brief 1/2019 sets out how HMRC expect businesses to account for VAT on these contracts from 01 June 2019. PCP and similar contracts are contracts that provide for the customer to pay a series of lease payments and then make a choice whether to pay a substantial payment to acquire the asset, or to return the asset at the end of a period of hire without making the substantial payment.

HMRC will determine the correct VAT treatment of such contracts based on the expected rational decision of the customer at the outset of the contract. For example, if the expected final payment is below the anticipated value of the item at that point in time, it will be regarded as a supply of goods from the outset. The change of practice is relevant to all business areas using similar arrangements, not just the motor industry.

Background

In 2017, the ECJ gave judgment in the Mercedes Benz case (Case C 164/16) concerning the correct VAT treatment of a finance purchase scheme called “Agility”. Customers acquiring a car could opt for a HP agreement (for someone wishing to spread payments), a leasing agreement (for someone not wishing to acquire the car) and an intermediate option, called an Agility Agreement, which contained an option to purchase for customers undecided about whether or not they would wish to acquire the car but wanting to keep their options open.

HMRC contended that supplies under the Agility Agreement amounted to supplies of goods pursuant to VATA Schedule 4 paragraph 1. This provides that if possession of goods is transferred under agreements which “expressly contemplate that the property in the goods will pass at some time in the future” then it amounts to a supply of goods. The appellant contended, on the basis of Article 14(2) that the supply was a supply of services. Article 14(2) provides that a supply under which goods change possession, not being a sale of the goods, will amount to a supply of goods where the terms provide “that in the normal course of events ownership is to pass at the latest upon payment of the final instalment”. The importance of the difference was that VAT was chargeable at the outset of the agreement if it was a supply of goods. However, if it was a supply of services, VAT was only chargeable each time the customer became liable to make a payment under the agreement.

The ECJ held that a judgement must be made by the supplier at the outset of the contract as to what the customer, acting as a "rational economic actor", would do when entitled to exercise a purchase option. If the customer could profitably sell the asset for more than the cost of the final optional payment, then if they act rationally it can be expected that they will buy the asset. However if the optional payment is expected to be the approximate open market value of the asset at the time the option must be exercised, then the customer may equally choose to purchase the asset or return it. In that situation, it cannot be expected at the outset that they will buy the asset. When considering this choice, additional circumstances that might impact individual decisions to purchase or not, such as access to funds, should not be taken into account. HMRC subsequently withdrew its appeal.

Future treatment

The Revenue & Customs Brief sets out how HMRC expect businesses to account for VAT on PCP and similar contracts with effect from 01 June 2019.

HMRC consider that the correct treatment of PCP and similar contracts depends on the level at which the final optional payment is set:

  • if, at the start of the contract, it is set at or above the anticipated market value of the goods at the time the option is to be exercised, the correct VAT treatment of the contract will be to treat it as a supply of leasing services from the outset and VAT must be accounted for on the full value of each instalment. There is no advance or credit, so there is no finance element.
  • if, at the start of the contract, it is set below the anticipated market value, such that a rational customer would buy the asset when they exercise the option, it is a supply of goods, with a separate supply of finance. VAT is due on the supply of goods in full at the outset of the contract, the finance is exempt from VAT.

HMRC will generally accept that the optional payment is set below the anticipated market value if it is below the value expected based on historical depreciation rates in immediately preceding years for the same or similar assets, such as the same model of car. Businesses may use another method to establish the anticipated open market value of the asset, providing it produces a credible assessment of future value, given information available at the time the assessment is made. Businesses must maintain, as part of their business and accounting records, evidence which demonstrates how they have arrived at the figures they have used.

Comment

All new contracts from 01 June 2019 falling within the ambit of the Business Brief must be accounted for in accordance with the new ruling. However, the Brief provides businesses with a range of option for dealing with any overpayments or underpayments of VAT where those contracts have been incorrectly treated as supplies of goods or services. Where a business has incorrectly classified its supplies as one of goods, then it may essentially do nothing or correct the VAT position by reclaiming overpaid VAT and then re-accounting for such VAT as it falls due. Where businesses have treated such contracts as supplies of services, but incorrectly treated part of the consideration as exempt finance, then the error must be corrected or the business must treat the supply as one of goods.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.