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CJEU clarifies VAT treatment of Mercedes' hire purchase contracts

A hire purchase-style contract containing an option to purchase should only be treated as a 'supply of goods' for VAT purposes if exercising that option is the lessee's "only economically rational choice", the EU's highest court has ruled.05 Oct 2017

The judgment means that Mercedes-Benz's 'Agility' financial product, under which the lessee must pay 40% of the vehicle price in order to take ownership of the vehicle at the end of the lease period, should be treated as a supply of services rather than a supply of goods. Under a supply of services VAT is paid by reference to when each instalment is paid. In contrast under a supply of goods, VAT is paid on the whole amount when the goods are handed over.

VAT expert Stuart Walsh of Pinsent Masons, the law firm behind Out-Law.com, said that the Court of Justice of the European and Union (CJEU) had "attempted to combine certainty with fairness" in its judgment.

"As the Agility product requires the purchaser to make a payment of around 40% of the total price, then exercising the purchase option is certainly not the customer's only rational choice," he said. "In which case, the product should be treated as a supply of services not goods."

"It will be left for taxpayers, authorities and the courts to determine whether the exercise of the option requires a 'substantial' payment to be made by the customer. In the Agility case, it seems clear that 40% of the total value must qualify as being substantial. However, could the same be said for a product requiring 20% of the total value to be paid?" he said.

As a result of the judgment, it was likely that VAT would have been overpaid. Customers and car manufacturers "will be keen to recover this overpaid tax", Walsh said.

"Overall, this must be a pleasing judgment for taxpayers and welcome news for the car industry at a time of uncertainty," he said.

Agility is one of a number of products offered by Mercedes-Benz Financial Services (MBFS) to finance the hire or purchase of Mercedes vehicles, alongside traditional leasing and hire purchase (HP) agreements. 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'.

The EU's VAT directive and UK implementing legislation 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. It was the position of HM Revenue and Customs (HMRC) that the Agility agreement meets this criterion, and should therefore be treated as a supply of goods. MBFS had challenged this, pointing out that only around half of its customers ultimately take advantage of the option to purchase.

In its judgment, the CJEU said that the 'normal course of events' test required two conditions to be satisfied. The contract must firstly contain a clause expressly relating to the transfer of ownership of the goods from the lessor to lessee. It must also be clear from the terms of the contract that the lessee will automatically acquire ownership of the goods "if performance of the contract proceeds normally, over the full term of the contract", at the time when the contract is signed.

The CJEU cited an opinion by its advocate general in the case, published in June. In his detailed opinion, advocate general Szpunar said that a "contractually determined outcome" of ownership being transferred was "incompatible with a genuine economic alternative for the lessee" at the point when that choice had to be made.

"The position would be different only if exercising the option to purchase, optional though it is in formal terms, appeared in fact, given the financial terms of the agreement, to be the only economically rational choice the lessee could make," the court said. "That may in particular be the case where it is evident from the agreement that, when the possibility of exercising the option arises, the aggregate of the contractual instalments will correspond to the market value of the goods, including the cost of financing, and that the lessee will not be required, as a result of exercising the option, to pay a substantial additional sum."

Whether an individual contract met those conditions was a fact-specific question, to be determined by the national court, the CJEU said.