EU advocate general attempts to further clarify VAT treatment of leases

The complex opinion from advocate general Maciej Szpunar "attempts to add some certainty to the difficult world of leasing", according to VAT and indirect taxes expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com. Opinions of advocates general are not binding on the Court of Justice of the European Union (CJEU), but are followed in the majority of cases.

The CJEU has been asked by the English Court of Appeal to rule on whether Mercedes-Benz's 'Agility' financial product should be classed as a supply of goods or a supply of services. Agility is one of a number of products, which also include traditional leasing and hire purchase (HP) arrangements, offered by Mercedes-Benz Financial Services (MBFS) to finance the hire or purchase of Mercedes vehicles.

The Agility agreement is marketed as an HP contract, but 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'. Around half of all customers take advantage of the option to purchase, according to the Court of Appeal.

CJEU case law has established that lease agreements should, as a rule, be treated as supplies of services. However, the position of HM Revenue and Customs (HMRC) in this case is that the Agility agreement should be treated as a supply of goods. Its view is 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 AG was required to interpret the meaning of "in the normal course of events". Conscious of the need for certainty, the AG used an economic choice analysis. Where the quantum of the lease payments was such that, over time, the lessee had paid the full price of the asset in question (and typically only a small further option fee was required), then the only economically rational position was that the lessee was likely to take ownership of the asset.

In the case of the Agility product, by the time the agreement has run its course only around 60% of the value of the vehicle had been paid. As the final payment consisted of 40% of the vehicle price, the lessee faced a genuine choice as to whether to exercise the option and take ownership. In which case, the Agility product could not be said, with certainty, to provide for the transfer of ownership in the normal course of events and thus should be treated as a supply of services.

The AG also considered the wider application of the judgment in the 2012 Eon Aset Menidjmunt case, where the CJEU ruled that a leasing agreement could be considered a supply of goods in certain circumstances. Specifically, these are where either ownership of the goods transfers to the lessee at the end of the lease, or where the lessee enjoys "all the essential powers attaching to ownership" of the goods and has in effect paid the market value of the goods in lease payments. The CJEU further clarified "essential powers" as "substantially all the rewards and risks incidental to legal ownership".

The CJEU based its decision in the Eon Aset Menidjmunt case on International Accounting Standard (IAS) 17 on leases, specifically its provisions on so-called 'finance leases'. However, the advocate general said that this should not be taken as meaning that every 'finance lease' under IAS 17 should be treated as a supply of goods. This was because legal regulations were "based on a different logic" to accounting standards, he said.

"The proper legal classification of specific contractual solutions and the ability of the authorities (administrative and judicial) to examine this classification in a foreseeable manner are more important here than is the economic outcome of the transaction," he said. "The legal classification must correspond to an objective assessment of the transaction as a concrete legal event, and the assessment should, so far as possible, be shared by all involved in the legal relations."

As such, the AG identified that it was likely that Eon had pushed the boundaries of the goods analysis too wide and risked including leases which are, correctly, treated as supplies of services.

"It will be interesting to see whether the CJEU follows the AG's opinion in this matter" said Mellor-Clark. "Should it do so, then it is likely that many leasing customers will have paid too much VAT at the inception of car finance products such as Agility. Suppliers should consider the appropriate mechanisms for recovering overpaid VAT. Any such decision may also have wider implications beyond the car finance world."