Many private vehicles are now leased under personal contract purchase agreements rather than being bought outright. Neil Warren discusses HMRC’s revised policy for the VAT treatment of such contracts.
Goods or services?
Customer perception is an important part of the VAT world and has reared its head in an important change to the way that VAT is dealt with by dealers who supply assets (eg motor vehicles) through personal contract purchases (PCP). Under such agreements, the customer usually makes monthly payments during the agreement period, with an optional payment at the end of the term.
The challenge is to consider the customer’s likely reaction to the amount of the final optional payment they make to acquire the asset, or whether they choose to return it to the dealer. This outcome determines whether payments made throughout the contract should be all standard rated for the lease of the asset (ie a supply of services) or whether they should be treated as a mixed supply of standard-rated goods (the asset) and exempt interest charges (the finance cost).
The change in HMRC policy announced in Revenue and Customs Brief 01(2019) follows HMRC’s review of the European Court of Justice decision in the case of Mercedes Benz Financial Services (C164/16). The end result is that PCPs will largely be indistinguishable from Personal Contract Hire (PCH).
Jack acquired a new van on a PCP which was worth £24,000 at the time he took possession of it. He will pay £500 per month for 36 months, with the option to purchase it at the end of the agreement for £12,000 – or return it to the dealer.
Working on a 25% reducing balance method of depreciation, the vehicle will probably be worth about £10,000 at the end of the three-year agreement. It is therefore likely that Jack, acting as what HMRC describe as a “rational economic actor,” will return rather than retain the vehicle. This means that the £500 per month payments are all standard rated as a supply of vehicle leasing (output tax = £500 x 36 months x 1/6 = £3,000).
Jill acquired a new car on a PCP, also worth £24,000. She will pay £750 per month for 36 months, with the option to purchase it at the end of the agreement for £3,000 or return it to the dealer. The car is also worth £10,000 after three years.
In this situation, the £3,000 final payment is clearly a good deal for Jill so in the ‘normal course of events’ (another phrase quoted in HMRC’s Brief) she is likely to purchase the car by making the final payment. The deal, therefore, represents a supply of both standard-rated goods and exempt finance. Output tax is payable at the beginning of agreement on the value of the goods (when Jill picks up the keys to the vehicle), with the balance of the payments being an exempt supply of credit.
The Revenue and Customs Brief 1(2019) also gives guidance on how to deal with past adjustments for those businesses that submitted error correction notices to HMRC while the Mercedes case was pending. However, a change in the balance between taxable and exempt income will also mean an input tax adjustment will be needed under the rules of partial exemption.
Businesses supplying PCP or similar contracts must apply the correct VAT calculation process for all new contracts from 1 June 2019 at the latest.
Many analysts think it is perhaps a bit optimistic of HMRC to expect businesses to change their accounting systems within three months when HMRC itself took nearly two years to review the Mercedes verdict.
Watch the input tax
Although this issue will be mainly relevant for vehicle suppliers, it is always important for businesses buying vehicles (particularly vans) to know what input tax can be claimed and when. Don’t forget that 50% input tax can be claimed on leasing cars, as long as there is some business use, whereas a block applies to most outright purchases of cars.
About Neil Warren
Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.