Changes to VAT treatment of PCP contracts

HMRC is highlighting changes to the VAT treatment of personal contract purchases (PCP) and similar contracts, which were previously viewed as supplies of goods and a separate supply of credit, but which in some instances are now considered to be a single supply of taxable leasing services

PCP or similar contracts provide for the customer to pay a series of lease payments and then make a choice whether to pay a substantive payment to acquire the asset, or to return the asset at the end of a period of hire without making the substantive payment. They are commonly used in vehicle purchases.

Businesses must adopt the correct treatment for all new contracts no later than 1 June 2019.

The policy change follows a European Court of Justice (CJEU) decision, in relation to Mercedes Benz Financial Services (MBFS).

MBFS and HMRC litigated about the correct VAT treatment of MBFS’s PCP finance scheme called ‘Agility’. The CJEU concluded that a judgment must be made by the supplier at the outset of the contract as to what the customer, acting as a ‘rational economic actor’, would do when entitled to exercise a purchase option.

If the customer could profitably sell the asset for more than the cost of the final optional payment, then if they act rationally it can be expected that they will buy the asset.

However, if the optional payment is expected to be the approximate open market value of the asset at the time the option must be exercised, then the customer may equally choose to purchase the asset, or return it and so it cannot be expected at the outset that they will buy the asset.

When considering this choice, additional circumstances that might impact individual decisions to purchase or not, such as access to funds, should not be taken into account.

Many businesses offer HP contracts where the final instalment is a substantive amount (‘balloon’ payments), similar to those in PCP contracts, however the final instalment is not optional under HP contracts. Such agreements normally have a much lower option fee to acquire the asset which is payable immediately after (effectively at the same time as) the balloon payment. Where the option fee is clearly below the anticipated market value of the asset these supplies are not affected by the MBFS ruling, regardless of the level at which the balloon payment is set.

HMRC’s briefing note says the correct treatment of PCP and similar contracts depends on the level at which the final optional payment is set.

If, at the start of the contract, it is set at or above the anticipated market value of the goods at the time the option is to be exercised, the VAT treatment of the contract will follow the MBFS judgment. It is a supply of leasing services from the outset and VAT must be accounted for on the full value of each instalment, there is no advance, or credit, so there is no finance.

However, if at the start of the contract, it is set below the anticipated market value, such that a rational customer would buy the asset when they exercise the option, it is a supply of goods, with a separate supply of finance. VAT is due on the supply of goods in full at the outset of the contract, while the finance is exempt from VAT.

HMRC will generally accept that the optional payment is set below the anticipated market value if it is below the value expected based on historical depreciation rates in immediately preceding years for the same or similar assets, such as the same model of car.

Businesses may use another method to establish the anticipated open market value of the asset, providing it produces a credible assessment of future value, given information available at the time the assessment is made.

Businesses must maintain, as part of their business and accounting records, evidence which demonstrates how they have arrived at the figures they have used.

Corrections

HMRC’s note contains detailed explanations of how businesses should correct past VAT periods, depending on whether or not they treated PCP as the supply of goods or of services, and whether or not the final optional payment was at or above open market value. 

If businesses have not treated their supplies in line with the judgment on their VAT returns, but have put in error correction notices (ECN) showing the VAT they considered would be due if HMRC’s appeal failed, HMRC says it will ask claimants how they calculated the final payment.

Those that have set the value of the final payment below the anticipated open market value of the goods at the time the option is due will have their ECN rejected by HMRC.

Businesses that have set the value of the substantive payment at or above open market value must, if they have accounted for VAT on only part of the instalment payments received, submit a further ECN to account for the difference between the VAT they have accounted for and the VAT due on the full instalment payments received. Alternatively they may withdraw the ECNs and treat the supplies as goods.

Businesses may need to make adjustments to their input tax where the proportion of taxable and exempt supplies they have made changes. These should be made at the same time as any adjustments to output tax, by following the normal error correction procedures.

Customers that have recovered VAT on PCP contracts which their supplier amends in the light of the MBFS judgment must adjust their claim accordingly.

Revenue and Customs Brief 1 (2019): Change to the VAT treatment of personal contract purchases is here.

Report by Pat Sweet

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