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HMRC internal manual

VAT Input Tax

Motoring expenses: cars bought for sale and leaseback

Purchase agency
Other types of sale and leaseback
Early termination payments and rebate of rentals

There are two basic types of sale and leaseback arrangement:

  • purchase agency; and
  • other types.

Purchase agency

A company, referred to as the operating company, enters into a sale and leaseback agreement with the leasing company before it buys its car fleet. The leasing company provides the funds for the initial purchase by the operating company.

For VAT purposes the operating company acts as the undisclosed purchasing agent of the leasing company. Title passes from the dealer to the leasing company immediately upon delivery of the car from the dealer to the operating company.

Under section 47 VAT Act 1994 there are deemed to be two simultaneous supplies. These are:

  • dealer to agent; and
  • agent to leasing company

The agent, in other words the operating company, must account for output tax and input tax in the same tax period.

In purchase agency arrangements HMRC will accept that the cars were bought by it for immediate resale. This is provided the operating company complies with all the requirements of section 47. The business can therefore claim input tax on those cars.

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Other types of sale and leaseback

In other types of sale and leaseback the operating company will buy its car fleet using its own or borrowed funds before it approaches a leasing company to arrange a sale and leaseback agreement. It will usually shop around for the best deal.

A common practice used by operating companies and local authorities is “quarterly draw-downs”. In quarterly draw-downs, at the end of each quarter the operator pools cars bought throughout the quarter. It then offers them for sale and leaseback.

In this type of arrangement there may be a long gap between the time when the operating company takes delivery of its cars and the time when it sells them to a leasing company. During that time the cars are usually allocated to employees and made available for private use.

HMRC has agreed that an operating company may recover input tax on its car purchases provided it can show that:

  • it has bought the cars with the intention of resale to a finance company; and
  • the sale takes place in the same tax period as the purchase.

The operating company should show that these conditions have been met by reference to written company policy and master vehicle agreements with one or more finance companies. Otherwise the operating company will not be entitled to input tax relief and the sale to the finance company will be one of a non-qualifying car.

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Early termination payments and rebate of rentals

When a finance lease is terminated early the lessee is normally charged a sum that represents the balance of the amount of rental that would have been payable over the full term of the lease. This is referred to as a termination charge.

This charge may be offset by a rebate based upon the residual value of the vehicle. In some cases the rebate may exceed the termination charge and the lessee may be due a net repayment.

Depending on the terms of the lease the leasing company will either:

If they are taxable the leasing company will normally offset the termination payment against the rebate and issue a tax invoice for the difference.

The 50% input tax block does not apply to the early termination charge. This is because it is not a charge for the rental of the vehicle.

If the rebate exceeds the termination payment the leasing company will issue a VAT credit note for the balance. If the VAT on the rentals was 50% restricted, the business will need to adjust only 50% of the VAT credit in their VAT account.

HMRC staff should refer to paragraph 7.10.10 ofV1-12 Valuation for more details on this.