Policy paper

Revenue and Customs Brief 1 (2019): Change to the VAT treatment of personal contract purchases

Published 27 February 2019

1. The purpose of this brief

To advise businesses how to treat personal contract purchases (PCP) and similar contracts following the European Court of Justice (CJEU) decision in Mercedes Benz Financial Services (MBFS). Previously HMRC regarded supplies made under such contracts as supplies of goods and a separate supply of credit. Following the MBFS decision we now consider that some of these contracts are a single supply of taxable leasing services.

This brief explains the circumstances where these contracts must be treated as a supply of leasing services, the date from when the change in treatment must be applied, and how to correct past periods where necessary.

2. Who should read this brief

You should read this brief if you make supplies using PCP or similar contracts. By similar contracts we mean contracts that provide for the customer to pay a series of lease payments and then make a choice whether to pay a substantive payment to acquire the asset, or to return the asset at the end of a period of hire without making the substantive payment.

3. Background

MBFS and HMRC litigated about the correct VAT treatment of MBFS’s PCP finance scheme called ‘Agility’. The case proceeded to the Court of Appeal (CoA) which made a reference to the CJEU to determine how the phrase “normal course of events” in Article 14(2) of the Principal VAT Directive should be interpreted.

In October 2017 the CJEU gave its ruling and HMRC subsequently withdrew its appeal.

The CJEU concluded that a judgment 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 and so 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.

4. Hire Purchase (HP) with a balloon payment

Many businesses offer HP contracts where the final instalment is a substantive amount (‘balloon’ payments), similar to those in PCP contracts, however the final instalment is not optional under HP contracts. Such agreements normally have a much lower option fee to acquire the asset which is payable immediately after (effectively at the same time as) the balloon payment. Where the option fee is clearly below the anticipated market value of the asset these supplies are not affected by the MBFS ruling, regardless of the level at which the balloon payment is set.

5. Correct treatment

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 VAT treatment of the contract will follow the MBFS judgment. It is 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

• 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.

6. Timing

Businesses must adopt the correct treatment for all new contracts no later than 1 June 2019. Correcting past VAT periods

6.1 Businesses which have treated their PCP or similar supplies as goods

That have set the final optional payment at or above open market value

This is an error as the supply is one of services. However if VAT has been accounted for in full up front on the goods supplied under those contracts businesses need not revisit their VAT accounting.

Alternatively they may choose to correct the VAT they have overcharged to date. They must not adjust for the VAT that has already fallen due and must account for VAT on future instalments, as they become due.

Adjustments must be made using the normal error correction procedure. Information on error corrections can be found in Notice 700/45: how to correct errors and make adjustments or claims.

That have set the final optional payment below open market value

Businesses that have accounted for the full amount of VAT at the outset of contracts have treated the supplies correctly and no changes to their VAT accounting are required.

6.2 Businesses which have treated their PCP or similar supplies as services

That set the value of the final payment at or above the anticipated open market value of the goods at the time the option is due to be exercised, and have erred by treating an element of each instalment as exempt finance

Businesses must account for the VAT due on the element they have incorrectly treated as finance by following the normal error correction process as explained in Notice 700/45

Alternatively, if they so choose businesses may treat all such supplies as though they were supplies of goods, and only adopt the revised treatment for all new contracts from a future date but not later than the 1 June 2019. They must use the VAT error correction procedure to declare the VAT due on the goods in full in the VAT period covering the beginning of the contract, offsetting any VAT they accounted for on instalment payments they have received.

That set the value of the final payment below the anticipated open market value of the asset at the time the option is due to be exercised; and treated the supply as one of leasing services and accounted for VAT on all or part of the instalments

Businesses must correct the error, following the normal error correction process as explained in Notice 700/45, by declaring the VAT due on the goods in full in the VAT period covering the beginning of the contract, offsetting any VAT they incorrectly accounted for on instalment payments they have received.

7. Previously submitted Error Correction Notices

If businesses have not treated their supplies in line with the judgment on their VAT returns, but have put in error correction notices (ECN) showing the VAT they considered would be due if HMRC’s appeal failed:

• HMRC will ask claimants how they calculated the final payment
• those that have set the value of the final payment below the anticipated open market value of the goods at the time the option is due will have their ECN rejected by HMRC
• those that have set the value of the substantive payment at or above open market value must, if they have accounted for VAT on only part of the instalment payments received, submit a further ECN to account for the difference between the VAT they have accounted for and the VAT due on the full instalment payments received
• alternatively they may withdraw the ECNs and treat the supplies as goods. They must adopt the correct treatment (as described above) for all new contracts from a future date commencing no later than 1 June 2019

8. Input tax

Businesses may need to make adjustments to their input tax where the proportion of taxable and exempt supplies they have made changes. These should be made at the same time as any adjustments to output tax, by following the normal error correction procedures.

9. Customers that have recovered VAT on PCP contracts

Customers that have recovered VAT on PCP contracts which their supplier amends in the light of the MBFS judgement must adjust their claim accordingly.

10. HMRC VAT Guidance

Our internal guidance, VAT SC72600; VATTOS9250; VATFIN3120 and section 4 of VAT Notice 701/49: finance, have been amended to reflect the MBFS judgement.