In HMRC v Mercedes-Benz Financial Services UK Ltd (C-164/16), the CJEU held that leasing arrangements, with an option to purchase, constitute a supply of goods for VAT purposes if transfer of ownership will follow “in the normal course of events”.
Motor companies commonly have several types of agreement by which a customer can acquire a vehicle. This case concerned a particular type of car hire finance package offered by Mercedes Benz (MB), which was part way between a typical hire purchase (HP) agreement and lease, known as an agility agreement. Under an agility agreement the customer paid monthly instalments in exchange for use of the vehicle for a specified period. At the end of the period, the customer had an option to purchase the vehicle in consideration for a “balloon” payment (varying between 42% and 48% of the initial purchase price).
In the view of HMRC, the agility agreement was a supply of goods within the meaning of Article 14(2)(b) of the Principal VAT Directive 2006/112/EC. HMRC therefore claimed full payment of VAT from MB in circumstances where the customer exercised the option to purchase.
MB challenged the classification before the First-tier Tribunal (FTT), arguing that the agility agreement, which did not necessarily provide for the transfer of ownership, had to be regarded as a supply of services and therefore VAT was chargeable only on each monthly instalment.
The FTT dismissed the application and MB appealed to the Upper Tribunal which allowed its appeal. HMRC appeal that decision to the Court of Appeal, which referred questions to the CJEU on the correct interpretation of Article 14(2)(b) of the VAT Directive.
The main issue for determination was whether such an agreement constitutes a supply of goods or services under the VAT Directive.
In May 2017, Advocate General Szpunar opined that the agility agreement constituted a supply of services. Article 14(2) of the Directive provides that “in the normal course of events” ownership is to pass at the latest upon payment of the final instalment. The AG stated that this only covers agreements where the right to purchase, although formally an option, is the only economically rational course of action. Where, as in this case, the lessee has a genuine choice whether to purchase, the agreement will be a supply of services for VAT purposes.
On 4 October 2017, the CJEU held, agreeing with the opinion of the AG, that the agreements were a supply of services for VAT purposes.
The CJEU commented that although the agility agreement might be referred to as a “finance lease” or “hire purchase” that was not, in itself, sufficient for it to be categorised as a transaction subject to VAT. In order for such an agreement to be considered a “supply of goods” it is also necessary to determine whether the agreement is a contract for hire which “provides in the normal course of events” that ownership is to pass “at the latest upon payment of the final instalment”, within the meaning of Article 14(2)(b).
To be classified as a supply of goods within Article 14(2)(b), the following two conditions must be satisfied:
• the agreement must contain a clause expressly relating to the transfer of ownership of the goods from the lessor to the lessee, and
• it must be clear from the terms of the agreement that ownership of the goods is intended to be acquired automatically by the lessee if performance of the contract proceeds normally over the full term of the contract.
In the present case, the decision to exercise the option to purchase involved a real economic and genuine choice and accordingly the CJEU concluded that the agreement was a supply of services for VAT purposes.
This is the CJEU’s first judgment directly dealing with the interpretation of Article 14(2)(b). The matter has now been referred back to the Court of Appeal for determination.
The judgment may have considerable practical implications for motor vehicle traders. The principle effect of classifying the agreement as a supply of services or supply of goods is the timing of when the taxpayer must pay VAT. If classified as a supply of service this can have significant cash flow advantages for taxpayers as they will not have to account for output VAT upfront, but when instalments are paid.
A copy of the judgment is available to view here.