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Test driving the tax rules on demonstrator cars


Get up to speed on the issues surrounding VAT and capital allowances on demonstrator cars with this overview from Rickie Lowrey.

13th May 2022
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A recent VAT case and an Any Answers query have touched on the taxation of demonstrator cars, so now is as good a time for a recap on the capital allowance and VAT treatment.

Car dealerships will often purchase an extra car to act as a demonstrator car. These demonstrators are usually the car that sits on display in the showroom and can also be the car that customers use for test drives.

This effectively puts all the test-drive mileage for that model/range onto a single car, leaving the others with pristine delivery mileage only. All the cars can then be sold at their full prices, with the “tarnished” demonstrator car being the only one that needs to be discounted.

Capital allowances

The capital allowance claims available for cars are potentially affected by both CO2 emissions and whether the car is new or second-hand. A new and unused zero-emissions car qualifies for a 100% first-year allowance, whereas the exact same second-hand car would only attract a deduction at the main rate of 18%, reducing balance.

Logically, you would expect a demonstrator car, which will likely have clocked up some miles from test drives, to be classed as used. However as pointed out by rmillaree on this Any Answers thread, HMRC state in CA23153 that they will accept a car is unused and first-hand even if it has been driven “a limited number of miles for the purposes of… test (driving)… or used as a demonstrator car”. 

So an electric ex-demonstrator car can still attract 100% first-year allowances, provided HMRC agree that the mileage to date of purchase by the business is “limited”. 

Input and output VAT

From the manufacturer’s point of view there will be nothing special about the demonstrator car, so they will charge VAT to the dealership the same as they would for any other car. As per section 3.2 of VAT Notice 700/64, provided the dealership intends to sell the car within 12 months, they can recover the VAT charged.

As VAT will have been recovered on the demonstrator car at purchase, the dealer will then be required to charge VAT on the full selling price.

Private use

Some dealerships allow their employees/directors to use demonstrator cars privately for no charge. Often the employees will not have an allocated car that they use but will rather treat the demonstrator vehicles similar to a fleet of pool cars.

Where such private use occurs, the default VAT treatment would be to account for output VAT each quarter on the cost of providing each car for private use. This would involve considering the depreciation of the car, the value of repairs and running costs and the business/private use split. 

However, the dealership can instead opt to use a simplified method; if chosen it must be used for all such privately used cars. 

Broadly, the list price of the car typically used by each affected employee is found and the table in section 25 of VAT Notice 700/57 used to find the output VAT amount to add to that quarter’s return. 

Note that for cars with a list price of £80,000 or more, the default calculation must be used for that car; however this will not prevent other, cheaper, cars being accounted for using the simplified method.

Rear view

Finally, a quick recap of a recent case that involved demonstrator cars.

R T Rate Limited (RTR) was a car dealership. In the past, the VAT treatment was such that its input VAT recovery was blocked, but it had to charge VAT on the onward car sale.

This did not match the EU treatment of similar transactions and so the onward sale of such cars was retrospectively changed to be exempt, going back to the start of VAT in 1973. 

Due to the long period covered, and as many affected traders may no longer hold adequate records, HMRC published a set of standard amounts (the “Italian Tables”) that could be used based on the category of car (prestige, volume and other) to simplify the process.

RTR made a claim in 2003 to recover all the affected VAT it had previously paid over, using the Italian Tables for its claim. Some 13 years later it was advised a more bespoke set of figures would have been more appropriate. It therefore sought to update its claim to increase it by £98,822.55.

HMRC considered this a new claim and so considered it out of time. The first tier tribunal agreed with them, so RTR appealed to the upper tribunal based mainly on the EU concepts of legitimate expectation and equal treatment.

Ultimately the upper tribunal found in favour of HMRC and dismissed the appeal on all grounds.

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