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CJEU: Hire Purchase Company should be able to recover some residual VAT


A proportion of the VAT on general business overheads should be recoverable by a hire purchase company, the Court of Justice of the European Union (CJEU) has decided in a case involving the financial arm of car manufacturer Volkswagen.

Volkswagen Financial Services (VWFS) is a member of the Volkswagen Group and offers hire purchase (HP) of VW vehicles to professionals and individuals. It has been in dispute with HM Revenue and Customs (HMRC) over the proportion of input tax paid on general business overheads and not directly attributable to particular supplies (residual VAT) that it is entitled to recover.

The residual VAT arose in relation to general expenditure, such as costs of staff training and recruitment, maintenance and enhancement of IT infrastructure as well as premises and stationery-related overheads.

When a customer wishes to purchase a car on HP, VWFS first purchases the car from the dealer and then supplies it to the end consumer on credit terms. The car is supplied to the customer at the same value for which VWFS acquired it from the dealer. However, when setting the interest rate for the finance aspect of the transaction, VWFS applies a margin for overheads, a profit margin and an allowance for bad debts to its own cost of financing the vehicle.

HP agreements are treated in the UK for VAT purposes as, amongst some other supplies, consisting of a separate taxable supply of the vehicle on the one hand, and, on the other hand, an exempt supply of credit.

HMRC argued that the residual VAT should be apportioned between the taxable and the exempt supplies based on the value of those supplies, but excluding the initial value of the vehicle when it is supplied. This had the effect of preventing the recovery of all but a very small amount of the residual VAT.

VWFS claimed that it should be entitled to recover the residual VAT based on the proportion of the number of taxable supplies to the total number of supplies in that sector, and that this should not be affected by the fact that the costs were only factored into the price of the finance, rather than the price of the vehicle itself.

CJEU Advocate General (AG) Maciej Szpunar said in a non-binding opinion in May that the UK's treatment of HP agreements was incorrect and that they should be treated as one single taxable transaction and not as two distinct transactions. This would mean that all input tax would be recoverable.

VAT expert Maryse Heijnen of Pinsent Masons, the law firm behind Out-Law.com, said: "However, the CJEU did not follow the same reasoning as the AG and said that there is nothing in the order of reference or the observations submitted to the Court to suggest that the UK did not apply the correct criteria in determining that a commercial transaction such as a HP agreement consists of multiple supplies."

"The change in VAT treatment of HP agreements, as suggested by the AG, would have had a major impact on the sector and how it accounts for VAT and the fact that the Court does not follow the AG's opinion is a welcoming result for the sector", she said.

The CJEU considered the questions raised by the UK Supreme Court and said that the fact that the general overheads were only factored into the price of the finance element of the HP transaction was irrelevant.

"In this case, it is apparent from the order for reference that the general costs at issue in the main proceedings have a direct and immediate link with the activities of VWFS as a whole, and not merely with some of them. In that regard, the fact that VWFS decided to include those costs not in the price of the taxable transactions, but solely in the price of the exempt transactions, can have no effect whatsoever on such a finding of fact," the Court said in its judgment.

Heujnen said: "The Court sets out that for costs to be a component of transactions, it does not necessarily mean that those costs will need to be included in the price of those transactions. This further explanation of the meaning of 'cost component', also seen in other recent decisions of the CJEU, will be helpful for taxpayers in arguing an entitlement to recovery of residual VAT in certain situations."

Where input VAT on general overheads is attributable to both taxable and exempt supplies, the proportion attributable to the taxable supplies has to be determined. The general rule is that the deductible proportion should be determined by reference to turnover. EU law allows tax authorities to use a different method, but only if the method used guarantees a more precise determination of the deductible proportion of the input VAT than the turnover method.

The Court referred to a 2014 case involving Banco Mais, which concerned recovery of overhead cost in relation to a bank leasing vehicles. In that case the CJEU held that the general overheads were used primarily as a consequence of the financing and management of leasing contracts and not of the provision of the vehicles. It decided that a turnover method of allocating the input tax should not take into account the element of the rentals paid by customers which related to the costs of the vehicles and should just consider the finance element.

The CJEU judgment in the Volkswagen case said: "it cannot be inferred from the Court’s reasoning [in the Baco Mais case]…that Article 173(2)(c) of the VAT Directive enables Member States, generally, to apply to all similar types of transactions in the automotive sector, such as the hire purchase transactions at issue in the main proceedings, a method of apportionment which does not take account of the value of the vehicle when it is supplied".

"Member States may not apply a method of apportionment which does not take account of the initial value of the goods concerned when they are supplied, since that method is not capable of ensuring a more precise apportionment than that which would arise from the application of the turnover-based allocation key," the CJEU said.

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