In October 2017, the European Court of Justice (CJEU) made a ruling on the litigation between Mercedes Benz Financial Services (MBFS) and HMRC regarding the correct VAT treatment of MBFS’s PCP finance scheme called ‘Agility’. As a result of this ruling, suppliers using PCP or similar contracts will have to consider each case individually to determine the correct VAT treatment.
More specifically, the emphasis is on whether individual PCP contracts should be classified as a supply of goods versus a supply of services, how to make the distinction, and how the VAT charge should be treated in both scenarios.
In this article, we’ll briefly look at:
- What is a PCP contract?
- What exactly is the change to the VAT treatment of PCP contracts?
- What is now the correct treatment of VAT on PCP contracts?
1. What is a PCP contract?
PCP stands for Personal Contract Purchase and is most commonly associated with car financing. Unlike Hire Purchase (HP), the financing is said to be only on the depreciation of the vehicle based on a guaranteed minimum future value (GMFV).
For example, say you purchase a car worth £15,000 and put down a deposit of £1,500. If the financing company determines that the GMFV will be £6,000 at the end of the financing contract, the financing amount will only be on the balance of £7,500. At the end of the contract, the buyer then has the option to either pay the £6,000 to take full ownership of the car (also known as a balloon payment), hand back the keys and walk away, or enter into another PCP contract for a new car.
The difference with an HP contract is that, HP financing will be on the purchase price of the car, minus the deposit (so no consideration of a GMFV). The balloon payment, although often smaller, is not optional.
2. What exactly is the change to the VAT treatment of PCP contracts?
Traditionally, PCP contracts, together with HPs, have been considered under a blanket treatment as a taxable supply of goods with a separate supply of credit, which is exempt from VAT. As such, with the supply of goods, VAT is accounted for upfront as a lump sum at the beginning of the lease contract and no VAT is accounted for on the monthly payments.
However, following the MBFS decision, and as outlined in Revenue and Customs Brief 1 (2019) issued on February 27th, HMRC now considers that some of these contracts are a single supply of taxable leasing services.
It means that if a PCP contract is determined to be a supply of a leasing service, instead of a supply of a goods plus credit, the VAT charge is spread over the term of the contract and based on the full monthly repayments, without making a distinction between the capital and financing element.
As a result of the Revenue and Customs Brief, businesses must adopt the correct treatment for all new contracts no later than 1 June 2019.
3. What is now the correct treatment of VAT on PCP contracts?
In short, it can either be treated as a supply of goods, or a supply of services. It all comes down to the GMFV and at what level the final optional payment is set at.
If the final optional payment (i.e. the balloon payment) is set at or above the anticipated market value (i.e. the GMFV) of the goods (e.g. a car) at the time the option is to be exercised, the contract will be deemed a supply of leasing services. VAT must be accounted for on the full value of each instalment, spread over the term of the contract. There is no advance, or credit, so there is no separate finance element.
However, if the final optional payment is set below the anticipated market value, such that any rational customer would choose to buy the asset when they exercise the option, the contract will be deemed a supply of goods with a separate supply of finance. VAT is therefore due on the supply of goods in full at the beginning of the contract and the finance element is exempt from VAT.
It is worth noting that these figures, i.e. the final balloon payment and the anticipated market value of the goods, are calculated at the beginning of the contract. HMRC have also stated that the anticipated market value will generally be accepted if it is based on historical depreciation rates in immediately preceding years for the same or similar assets, such as the same model of car. Other methods of calculating the value may be accepted providing it produces a credible assessment of future value, given the information available at the time the assessment is made.
HMRC has also outlined a number of specific scenarios to help you, as the supplier, to determine whether or not you have treated your past PCP and similar contracts correctly, and if not, what correcting VAT adjustments have to be made (if any). It is possible to make adjustments for the past 4 years if you have overpaid VAT.
This can get quite technical, so if you would prefer to speak to an expert, please give us a call on +44 (0)330 024 3200. Our experienced VAT professionals will be happy to lend a helping hand.