In Volkswagen Financial Services (UK) Ltd v HMRC8 , the Supreme Court decided that guidance is required from the ECJ in respect of HMRC’s approach to the apportionment of residual input tax.


Volkswagen Financial Services (UK) Limited (VFS) is a subsidiary of the Volkswagen Group. The company exists solely to provide prospective buyers of the Volkswagen Group’s vehicles with a hire purchase finance option. Where a customer purchased a vehicle on hire purchase, VFS would acquire the vehicle from a dealer and then supply the vehicle to the customer, charging the customer the same price as it had paid the dealer.

For VAT purposes, VFS was treated as making two separate supplies: a taxable supply of the vehicle (in respect of which it accounted for output tax on the price of the vehicle) and an exempt supply of finance. However, VFS could only deduct input tax in respect of the taxable supplies. Although some of its expenditure was directly attributable to the taxable supplies, some, such as expenditure on general business overheads, could not be directly attributed to specific supplies.

Given the difficulty in assessing which expenses could be deducted, HMRC agreed a partial exemption special method with VFS for valuing the proportion of the residual input tax attributable to the exempt transactions. VFS interpreted that method as enabling it to recover 50% of the input tax on its overheads on the basis that the overheads were wholly attributable to both the taxable and exempt supplies. However, HMRC considered that the overheads were wholly attributable to the exempt supplies of finance, and the input tax in respect of such supplies was therefore irrecoverable.

The FTT and the Court of Appeal found in favour of VFS, concluding that the overheads could be treated as cost components of both the taxable and exempt supplies. The UT supported HMRC’s approach that as the taxable supply was at cost, the overheads could only be attributable to the exempt supply.

The Supreme Court’s decision

With regard to the main issue in the appeal, whether any of the residual input tax in respect of general overheads was deductible, the Supreme Court decided that guidance was needed from the ECJ in order for it to reach a conclusion and it therefore made a reference to the ECJ. 

The Court’s judgment is therefore predominantly concerned with a secondary issue, which HMRC raised on appeal. This concerned whether HMRC had asked the FTT to consider, as an alternative to its principal argument, whether a lower figure than 50% should have been attributed to the taxable supplies and whether the FTT had failed to consider that question. The Court dismissed this ground of HMRC’s appeal. When the FTT, as in the instant case, is dealing with substantial litigants who are represented by experienced counsel, it is entitled to assume that the parties will have identified the relevant issues for determination. Having examined material, including the judge’s notes of the hearing in the FTT, it concluded that the FTT’s understanding and approach was consistent with the lack of any specific reference to the issue in HMRC’s written submissions or witness evidence. The Court found no material which could justify going behind the position as the FTT understood it. If, however, there had been any doubt, and if the FTT was thought to have misunderstood HMRC’s position and failed to deal with a significant issue, the matter should have been raised and dealt with at the time.


In general, it takes approximately 18 months from a reference being made to the ECJ to that Court delivering a judgment. Whilst this means the ECJ may provide its judgment before the UK leaves the EU (assuming the UK does leave the EU within two years of Article 50 being triggered), it will be some time before the Supreme Court is in a position to determine what proportion of residual input tax is recoverable by finance houses.

A copy of the judgment is available to view here.