Hire purchase agreement not necessarily supply of goods at the outset, UK tax tribunal rules

Financial services VAT expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com, said that the tribunal's decision implied that output tax on the hire of goods under an HP agreement was due over the lifetime of the contract, rather than right away (34-page / 131KB PDF). The tax treatment of the transaction would therefore depend on whether the hirer would normally take ownership of the goods at the end of that particular type of contract, or whether this was merely "one possible eventuality", he said.

"Businesses offering HP contracts with a similar choice as to whether or not to take title, as in this case, may wish to review their current arrangements and consider whether retrospective claims for overpaid output tax are appropriate, in light of this decision," he said.

In the UK, HP agreements are governed by the 1974 Consumer Credit Act. They allow goods to be paid for in instalments over a specified period of time. An HP agreement legally consists of two parts: a 'bailment', or hire, of the goods in return for periodic payments; and the eventual passing of title to the hirer on completion of payment and the exercising of an option or some other act.

From a VAT perspective, an HP agreement consists of the supply of the goods themselves along with a separate supply of credit, providing that the credit is separately disclosed and charged for. The 1994 VAT Act states that there is a supply of goods if the agreement expressly contemplates the passing of title to the goods at some point in the future but not later than when the goods are fully paid for. Traditionally, therefore, HM Revenue and Customs (HMRC) has required suppliers to account for output VAT on the full value of the goods when the contract is entered into. Under a plain lease agreement, liability for output tax arises on each payment made.

Mercedes-Benz Financial Services (MBFS) had challenged the tax treatment of its 'Agility' payment product in the tax tribunal. Agility was one of a number of products, which also included traditional leasing and HP arrangements, offered by the firm to finance the hire or purchase of Mercedes vehicles. Although described as an HP contract, the Agility plan offered lower monthly payments than a typical HP agreement and did not cover the full value of the vehicle. At the end of a specified time period, the hirer could then choose to buy the vehicle, paying a Guaranteed Future Value amounting to effectively the outstanding balance on the vehicle; to hand it back subject to terms and conditions with nothing else owing; or to exercise the option to purchase and use the vehicle in part exchange for a new vehicle.

In its initial judgment, the First Tier tax tribunal held that the Agility product amounted to a supply of goods for VAT purposes so that all the VAT was payable up front.. However, this decision has been reversed by the Upper Tribunal. In reaching his decision, Mr Justice Nugee considered the provisions set out in the EU's Principal VAT Directive, which the UK law is designed to implement. The Directive states that a supply of goods for VAT purposes occurs if "in the normal course of events ownership is to pass at the latest upon payment of the final instalment".

In his judgment, Mr Justice Nugee said that the Court of Justice of the European Union (CJEU) had not yet been asked to rule on the meaning of these particular words. However, he said that the question was one of whether the "economic purpose" of the contract was for the customer to acquire ownership of the vehicle. It was "easy to see" that this test was satisfied in the case of MBFS' traditional HP agreement, because even though there was no legal obligation on the customer to purchase the vehicle at the end of the payment term performance of the contract would "in fact" lead to the customer paying the entire purchase price and acquiring ownership for an additional minimal fee, he said.

"It is not sufficient for a contract to come within [the relevant provisions of the VAT Act] for it to contain a provision under which the hirer has an option to acquire the ownership of the vehicle at the end of the hire period, and that such acquisition is a normal outcome," he said. "In order for a contract to come within [the provisions] it must be the normal outcome of the contract ... by reference to the economic purpose of the contract that is by looking at the parties' respective interests which performance of the contract satisfies."

Darren Mellor-Clark said "The decision highlights the importance of considering a wide range of evidence when defining economic purpose. In particular contracts, marketing material and the fundamental economics should be considered,"