by Neil MacKay
The Court of Justice of the European Union’s (CJEU’s) much anticipated judgement in the Mercedes-Benz Financial Services UK Ltd case (Case C-164/16) was delivered on 4 October, providing greater clarity on the VAT treatment of personal contract purchase agreements offered by car manufacturers and other companies, as well as on leases in general.
Following the opinion of Advocate General Szpunar, the EU court concluded that personal contract purchase agreements can be a supply of goods or a supply of services, dependent on the circumstances.
Unlike a traditional hire purchase or installment plan agreements, a contract purchase agreement is typically structured so that the customer pays a low monthly amount over the contract period plus a final balloon payment at the end. The characterization of these arrangements for VAT purposes has been uncertain, giving rise to the instant dispute.
Goods or services?
The EU court found that there are two important elements that must be considered when ascertaining whether a personal contract purchase agreement, or any lease for that matter, is to be regarded as a supply of goods.
To be a supply of goods, there must be an agreement that contains a clause that transfers ownership of the leased asset from the lessor to the lessee. This can be automatic or an option to purchase.
Second, the transfer of ownership must occur ‘in the normal course of events’ where there is a degree of certainty that the lessee will take ownership of the subject-matter of the lease.
The court also said that transfer of ownership must take place upon the final installment that the lessee must pay under the agreement. This will happen where the mandatory installments equal the market price of the leased asset, whereby any final payment is nominal and insignificant – the lessee will be deemed to have no genuine choice but to take ownership of the leased asset (supply of goods).
However, where the installments do not represent market value, and the lessee is faced with a significant final payment (genuine choice), the personal contract purchase will be considered a supply of services, the court said.
Large final payment
Apply this analysis to the case at hand, the lease in question was considered a supply of services.
This is because this particular lease left its lessees with a final payment ranging from between 42%-48% of the total value of the asset. There is no certainty that any lessee would take up the option to purchase the asset, i.e. taking ownership, the court concluded.
Implications
The wider implications mean that businesses that continue to offer personal contract purchases that are not on market value terms can continue to benefit from increased cash flow by reclaiming 100% of the VAT back from their customer monthly payments.
Where personal contract purchases are used privately (members of staff), then they can reclaim 50% of the VAT.
Businesses that offer personal contract purchases on market value terms must weigh up the benefits of offering such a financial instrument to their customers. Without the VAT reclaim benefit, it may well be that they will be better off to only offer hire purchase agreements and standard leases.
Transfer of ownership
In its reasoning, the CJEU states that, as Article 14(2)(b) of the VAT directive does not refer to the transfer of the power to dispose of the property as owner, it is the transfer of ownership that is important. Therefore, an agreement that includes an option to purchase will be considered to contain an express ownership transfer clause.
In addition, it must be clear that ownership intends to pass on the final payment. Where the personal contract purchase offers the customer a genuine economic rational choice to purchase the car, then this is incompatible with the transfer of ownership.
This happens where the installments do not correspond with the market value of the goods, namely, where the customer is faced with a substantial additional sum. In such instance, the PCP will be declared a supply of services.
Alternatively, where the installments do correspond to the market value of the goods, i.e., there is no genuine economic rational choice to make, then ownership will be deemed to have transferred to the customer upon the final payment – a supply of goods.
Clarity
The case provides much needed clarity on how to interpret personal contract purchases in relation to Article 14(2)(b) of the Directive 2006/112/EC, incorporated into UK domestic law via paragraph 2(b) of schedule 4 to the Value Added Tax Act 1994.
The purpose of the case was to define what was meant by the words “a contract . . . which provides that in the normal course of events ownership is to pass at the latest upon payment of the final installment,” as contained in Article 14(2)(b) of the Directive.
Traditional case law has always held that personal contract purchases are a supply of services (Case C-190/95 ARO Lease). However, the recent judgment in Eon Aset Menidjmunt (Case C-118/11) highlighted that not all personal contract purchases give rise to a supply of services.
In that case, the CJEU held that a personal contract purchase could be a supply of goods where the installments were virtually the same as the market value of the subject matter of the leasing agreement.
This contrast meant that the CJEU, in this case, had the opportunity to be more precise as to when a personal contract purchase would give rise to a supply of goods, like the Advocate General did in his opinion.
Thus, in relation to this judgment, where installments that do not provide a degree of certainty that the lessee will take ownership of the asset, it is the size of the final payment that determines such.
This interrelates with the size of the installments also; the larger the final payment, then the greater likelihood that the installments are not in line with market value, i.e., the more likely a personal contract purchase will be classified as a supply of services.
––Neil MacKay has a LL.M. in Advanced Legal Studies from University of Warwick. He can be reached at [email protected]
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