In a recent case the Upper Tribunal had to decide if a motor finance product offered by Mercedes-Benz was a supply of goods or a supply of services, with important implications for the imposition of VAT. James Baird explains the Tribunal’s decision
You may think when you hire a Mercedes (or any other vehicle) that for VAT purposes, it will always be treated the same way. But a recent case (see Mercedes-Benz Financial Services UK Ltd v Revenue and Customs Commissioners (2014) UKUT 0200) indicates this is not so.
Go deeper with GlobalData
Access deeper industry intelligence
Experience unmatched clarity with a single platform that combines unique data, AI, and human expertise.
HMRC’s view
HMRC argued that a motor vehicle finance agreement called "Agility" was a supply of goods. The Upper Tribunal held that it was, in fact, a supply of services.
This may seem surprising, but the reasons for the decision are explained below. This will have major cash flow implications for the vehicle leasing industry.
Mercedes product offering
US Tariffs are shifting - will you react or anticipate?
Don’t let policy changes catch you off guard. Stay proactive with real-time data and expert analysis.
By GlobalDataMercedes offered its customers the use of a vehicle in three ways: leasing, hire purchase and Agility. Under each, the customer made monthly payments for a specified period. Under both HP and Agility the customer had the option at the end of the period to acquire the vehicle. If customers decided at the outset that they would like to purchase the vehicle, an HP product would be recommended.
If they had decided that they definitely didn’t want to purchase the vehicle, a leasing product would be recommended. For customers wanting to keep their options open, the Agility product would be recommended. Both the HP and Agility agreements contained a right for the customer to terminate the arrangement as required by the Consumer Credit Act.
VAT Treatment
The VAT treatment differed depending on the choice made. Under a lease, Mercedes would be liable to account for VAT on the rental payments made each month. On HP, Mercedes was liable to account for VAT on the entire purchase price upfront, with an adjustment if customers exercised their right to terminate.
If the Agility agreement was treated as HP, Mercedes would be liable to account for VAT upfront on the entire purchase price, with an adjustment if the customer did not exercise the option at the end of the contract. Roughly 50% of customers chose not to exercise the option and returned the vehicle. By the time of the hearing in March 2014, Mercedes estimated the VAT at issue was around £160m.
Tribunal’s decision
In deciding that the Agility agreement was one of hire and not HP, the Upper Tribunal noted that it had similarities to both types of contract. Although it was described as an HP agreement (as required by the Consumer Credit Act) and there was an option to purchase at the end of the contract and both contracts also contained a right to terminate, this did not make Agility a contract for the supply of goods.
Even though the payments (deposit, monthly payment and balloon payment/option fee) were structured the same in some HP agreements as in the Agility contract, the economic interests of the parties were different.
In the HP agreements, the customer was contractually obliged to pay all of the payments (excluding the £95 option fee), including the balloon payment (the Upper Tribunal ignored the statutory right of termination). It would not, therefore, be in the economic interests of the customer to fail to exercise the option. Under the Agility agreement, the customer was left with a real choice as to whether to exercise the option and was under no contractual obligation to do so. The optional purchase payment under Agility equated to 44% of the value of the vehicle, which was estimated to be its residual value at the end of three years.
Implications of the decision
While this case will not affect HP agreements where the customer is contractually obliged over the life of the contract to pay the entire price for the vehicle, it should give certainty (and a cash flow benefit) to those situations where there’s no such contractual obligation and the customer has a genuine choice as to whether to pay the difference and keep the vehicle, or hand it back.
It’s also worth noting that all of the options involved the customer obtaining the use of a Mercedes over the 36-month period, but only one – the HP agreement – was treated as a supply of goods so that VAT was payable on the full price at the outset. The lease and the Agility product were held legally to be the supply of services for VAT purposes.
Leases are not, therefore, a credit agreement but a supply of services/hire agreement under VAT law. Contrast this outcome with accounting standards (not law) as to whether, the Agility product was a finance lease or an operating lease. Finance leases are accounted for (following international accounting standards) as credit, but operating leases are brought into account as an expense.
Operating lease v finance lease debate
Whether the Agility product was a finance lease or an operating lease was not considered by the court but it’s arguable that it has some characteristics of both. Critically, the designation for VAT purposes is one factor in determining whether in law a lease is credit or not.
The taxation and accounting treatment of a finance agreement may not match in all cases and accounting treatment following internationally agreed standards is not a test of a lease’s designation in law. It is suggested the VAT treatment is a stronger determinative factor of legal status.
James Baird is a partner at Gateley
