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UK: Partial VAT recovery, costs related to hire-purchase agreements

UK: Partial VAT recovery, hire-purchase agreements

The Court of Justice of the European Union (CJEU) issued a judgment concluding that concerning a hire-purchase agreement, the supply of a vehicle and supplies of credit can be treated as separate supplies for value added tax (VAT) purposes.

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Even though the taxpayer (a financial services entity) realized no profit with the supply of vehicles, the judgment provides the VAT recovery method could take account an actual and non-negligible allocation of general costs to transactions giving rise to a right to recover input VAT. The judgment may provide opportunities for taxpayers in the leasing sector.

The case is: Volkswagen Financial Services (UK) Ltd. (C-153/17, 18 October 2018).

Background

The taxpayer offers customers a hire-purchase agreement that was divided into (1) the supply of a car and (2) the provision of a loan. 

  • The supply of the car was treated as taxable, with the price for the supply of the car being equal to the price that the taxpayer paid to a dealer to buy the car. 
  • The provision of the loan was treated as exempt. The taxpayer’s profits were derived from the provision of loans. 

At issue was whether the taxpayer could recover input VAT on general costs. 

CJEU judgment

The CJEU addressed whether the various transactions relating to hire-purchase supplies are treated as distinct transactions for VAT purposes, and thus taxable separately, or treated as a single complex transaction composed of several elements. The CJEU followed the UK court’s view that each car hire-purchase agreement consisted of several separate supplies—the supply of a vehicle, and supplies of credit. The CJEU held that the supply of credit was VAT-exempt, as long as the payment of interest did not constitute part of the consideration obtained for the supply of goods or services, but only a consideration for the granting of that credit. In reaching this conclusion, the CJEU recognized that deferred payment of the purchase price of goods could be treated as the provision of a VAT-exempt loan. 

With regard to the recovery entitlement for VAT on overhead costs, the CJEU held that even though the taxpayer decided to include only the overhead costs in the price of exempt transactions and not in the price of the taxable transactions, the general costs at issue had a direct and immediate link with all of the taxpayer’s activities, and not merely with the loans. Accordingly, the VAT on these general costs would be partially recoverable. 

As a general rule, VAT recovery for overhead costs must be determined by reference to turnover. However, EU Member States may apply a method or allocation key other than the turnover-based method, based on a condition that the method used provides a more precise determination of the deductible proportion of the input VAT. The UK tax authorities had argued that the turnover generated by the sale of the vehicles would not be taken into account when calculating the taxpayer’s recovery rate. The CJEU however determined that a method that does not take account of the value of the vehicles was not permissible, since that method did not provide a more precise apportionment than that which would arise from the application of the turnover-based allocation key. The CJEU found that an alternative method would take account of an actual and non-negligible allocation of general costs to transactions giving rise to a VAT recovery right. 

KPMG observation

The CJEU’s judgment did not follow the opinion of the CJEU Advocate General who found that a hire-purchase agreement qualifies as a single taxable supply. The judgment of the CJEU appears to be in line with the Dutch VAT practice. Similar to the UK position, hire-purchase arrangements and certain financial leases can, under certain conditions, be separated into a taxable supply of goods and the VAT-exempt provision of a loan. 

The CJEU’s judgment appears to provide an opportunity for taxpayers that have been confronted with input VAT recovery restrictions following earlier case law from the CJEU. In the instant case, the CJEU held that for the calculation of the VAT recovery entitlement on overhead costs, rental payments made by customers would not be taken into account if the use of the overhead costs were primarily caused by the (VAT-exempt) financing and management of those contracts. Taxpayers operating in the leasing industry may want to explore possibilities under the input VAT recovery method. 

 

Read an October 2018 report prepared by the KPMG member firm in the Netherlands

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