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HMRC internal manual

VAT Partial Exemption Guidance

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HM Revenue & Customs
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Guidance for specific trade sectors: finance: finance houses: attribution of input tax on overheads

In September 1984, Customs entered into an agreement with the Finance Houses Association Ltd (FHA), which allowed their members to recover 15% of the VAT incurred on general overheads used in carrying on their HP business. However, following consultation with their successors, the Finance and Leasing Association, that agreement was withdrawn on 31 January 2000. Many finance houses have continued to use the defunct agreement in formulating proposals for special methods.

On 11 February 2004, HMRC wrote to the FLA concerning the treatment of such general overheads. We stated we did not accept that the value of the goods supplied under the finance agreement should be used to determine the recovery of the residual input tax. This is because there is no direct and immediate link between the costs and the supply of goods - the overheads only being included in the price of the credit.

When considering PE methods, the following points need to be considered:

  • It is usually necessary to identify, by an agreed means, the proportion of residual expenditure relating to leasing, instalment credit finance (or hire purchase) and any other activities (e.g. unit stocking, lending etc). Whatever fraction is used should be an acceptable proxy for ascertaining the use of the expenses in each area.
  • Input tax incurred by a finance house on the purchase of goods to supply under a hire purchase, lease-purchase or leasing agreement would normally be fully recoverable as being directly related to an onward taxable supply of goods or services.
  • Input tax incurred on general overheads used in making taxable leasing services, would also be recoverable under the terms of any PE method.

HMRC is concerned about HP arrangements that fit the following criteria:

  • The finance house supplies the goods under a hire purchase or lease-purchase agreement at the same price as that charged by the dealer so that the input tax incurred on the goods and the output tax chargeable is the same amount.
  • The remaining charges made by the finance-house under the agreement are treated as exempt under Group 5 of Schedule 9 to the VAT Act 1994 (with the possible exception of some option fees).

HMRC does not consider that there is any direct and immediate link between the input tax on general overheads and such goods. However there is a clear direct and immediate link to the provision of exempt credit.

The reason for this is as follows - There is no margin on the goods and so the overhead costs are not included in the price for them. Support for this view comes from Article 1(2) of the Principal VAT Directive (formerly Article 2 of the First Directive), which states as follows:

“The principle of the common system of VAT entails the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services… 

On each transaction, VAT, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of VAT borne directly by the various cost components” 

Article 168(a) of the principal VAT Directive (2006/112/EC) (formerly Article 17(2)(a) of the Sixth Directive) simply refines these fundamental principles and therefore needs to be interpreted consistently with them. In Southern Primary [2004] STC P209, the Court of Appeal equated “use” with the term “cost component” as used in Article 1 (2) of the Principal VAT Directive (formerly Article 2 of the First Directive).

An acceptable PE method should recognise that general overheads do not form a cost component of the supply of goods where those goods are sold on at cost by the finance house. Such supplies need to be excluded from any fraction used solely for determining recoverable input tax on general overheads used in HP transactions.

There may be circumstances when an uplift is applied by the HP Company, for example because a discount is not passed on to its customer. In that case there would clearly be some use of overheads in making the taxable supplies. However, if only a nominal uplift is applied, then this should only have a slight effect on the total amount of residual input tax recoverable.

The value of such goods should not however be excluded from any allocation of residual input tax between sectors or different classes of transaction within a sector such as HP or leasing. (See PE22500 - Allocation in special methods). To do so would overstate the extent to which general out puts are used in making leasing supplies.