The “Agility” motor finance agreement is a supply of services and not goods meaning output VAT is not due upfront.

The Court of Justice of the European Union (CJEU) found in favour of Mercedes-Benz Financial Services UK Ltd (“MBFS”) in a long running case concerning the VAT treatment of a specific type of car leasing agreement. This decision is likely to have significant implications for the automotive finance sector given that output VAT is not required to be paid upfront on a supply of services, but only when instalments are paid.

As a result of the judgement, VAT may have been overpaid by customers and car manufacturers. HMRC have yet to issue a VAT Briefing outlining their position post this decision.

Background

The case concerned the VAT treatment of a specific motor vehicle finance agreement called “Agility” which MBFS offered to customers undecided as to whether they want to own the car or want to keep open the option to purchase or not.

The Agility agreement is marketed as a hire purchase contract. However, the contract offers lower monthly payments than a typical HP agreement and does not cover the full value of the vehicle. It allows the customer to lease the vehicle for a prescribed period, after which the customer can purchase it subject to payment of a final ‘optional purchase payment’. According to the Court of Appeal, about 50 per cent of all customers take advantage of the option to purchase after the prescribed period.

MBFS considers Agility to be a rental agreement with an option to purchase and therefore, treated its supplies as services for VAT purposes.

CJEU case law has established that lease agreements should, as a rule, be treated as supplies of services. However, HMRC argued that the Agility agreement should be treated as a supply of goods. Its view was that this is in keeping with the wording of the VAT Directive, which provides that a contract where ‘in the normal course of events, ownership is to pass at the latest upon payment of the final instalment’ is a supply of goods.

The case was taken to the CJEU by HMRC from the UK Court of Appeal.

Decision

The CJEU took the view that legal certainty requires that lease agreements should be regarded as supplies of goods for the purpose of levying VAT only when it can be assumed with certainty that in the normal course of events, at the latest by the end of the agreement term, ownership of the subject matter of the leasing agreement will be transferred to the lessee.

The CJEU noted that the label attached to a specific agreement for the hiring of a motor vehicle with an option to purchase (e.g. ‘finance lease’ or ‘hire purchase’) is not determinative as to whether the supply is one of goods or services for VAT purposes.

The Court then set out the tests to determine whether a supply falls to be treated as goods under Article 14(2)(b) of the VAT directive as follows:-

• the contract must include a clause expressly relating to the transfer of ownership of the goods; and
• objectively assessed, ownership of the goods will pass automatically through the normal performance, over the full term, of the contract.

In a contract where the first of the above tests is met but where the transfer of ownership of the goods is not automatic and is one of a number of options available to the customer (other options being for example to return the goods or extend the hire period), the second test above will not be met. Thus the contract will not fall within Article 14(2)(b) to be treated as a supply of goods.

However, the contract will fall within Article 14(2)(b), where

• the contractual instalments correspond to the market value of the goods including financing; and
• the customer will not be required to pay a substantial additional fee in order to exercise the option to purchase.

The full judgement of the Supreme Court is available to read on www.bailli.org.