The Upper Tribunal (UT) allowed the appeal by Mercedes-Benz Financial Services UK Ltd (MBFS) against the decision of the First Tier Tribunal (FTT) ([2013] TC 02778) and held that the vehicle finance agreement with the customers of MBFS constituted a supply of services, rather than of goods on deferred terms.

The case, Mercedes-Benz Financial Services UK Ltd v Revenue and Customs Commissioners [2014] UKUT 200 (TCC), revolved around whether a motor vehicle finance agreement called Agility was a supply of goods or services under EU Directive 2006/112, article 14(2)(b).

MBFS provided asset-backed financial products and ancillary services to its customers when they purchased or leased motor vehicles from retail dealers. In August 2007, MBFS entered into a vehicle finance agreement (the Agility agreement) with its customers, which supplemented its existing finance options of hire purchase and leasing. MBFS marketed the Agility agreement as a distinct financial product, giving the customer in respect of the motor vehicle at the end of the agreement a choice of three options: (1) purchase, (2) return and (3) purchase and part-exchange.

Under the agreement, customers had to make monthly payments to discharge the credit, including interest, they borrowed in respect of a vehicle. In return, they were entitled to possess the vehicle. It also gave them an option to purchase once they made all payments due under the agreement, except the optional purchase payment and purchase activation fee. The option to purchase was exercised only by making the optional purchase payment by the due date. MBFS retained the ownership of the vehicle until the customers had exercised the option to purchase and made all required payments.

If the customers did not opt to purchase, they had to return the vehicle to MBFS in good condition. If they returned the vehicle, they might be liable for excess distance and damage charges. The agreement allowed for payment of a deposit. It also specified financial information, such as the total payable, the total cash price of vehicle and the total charge for credit.
MBFS contended that the agreement constitutes a supply of services. HMRC contended that it constitutes a supply of goods.

The appeal focused on three issues:

(1) that the FTT made an error of law in its interpretation of the relevant legislation, namely art 14(2)(b);

(2) that the FTT made findings of fact that had not been contended for by HMRC and in so doing acted in a procedurally unfair way; and

(3) that in any event those findings were misconceived.

Upper Tribunal decision

The UT referred to these as ‘the Interpretation Issue’, ‘the Procedural Issue’ and ‘the Factual Issue’ respectively.

Article 14(2) provides that ‘each of the following shall be regarded as a supply of goods . . . (b) the actual handing over of goods pursuant to a contract for the hire of goods for a certain period, or for the sale of goods on deferred terms, which provides that in the normal course of events ownership is to pass at the latest upon payment of the final instalment’.

(1) The interpretation issue

The Agility agreement as a matter of English law is not a transfer of the whole property in goods, but is a transfer of possession of goods. It is not an agreement for sale of the goods as there may never be a sale, this being a matter at the option of the purchaser (para 18 of the decision).

The question is whether the Agility agreement falls within art 14(2)(b). It is a contract for the hire of goods for a certain period under which there is an actual handing over of the goods, so this resolves itself into the question whether the Agility agreement is a contract which provides that in the normal course of events ownership is to pass at the latest on payment of the final instalment (para 19 of the decision).

The UT considered why art 14(2)(b) provides for certain contracts, which do not necessarily lead to a transfer of ownership, nonetheless to be treated as a supply of goods. At para 42, the UT held that the discernible policy purpose behind the inclusion of certain contracts of hire in art. 14(2)(b) is to tax transactions where the customer has in reality agreed to buy the goods as if they were contracts of sale, even though in law the customer is not contractually obliged to complete the purchase.

The UT considered how to ascertain whether a contract is one under which the ownership will normally pass. At para 48, the UT held that the question under art 14(2)(b) is whether the contract is one whose economic purpose is for the customer to acquire ownership of the goods. This is to be identified by looking at the interests which performance of the contract satisfies or by looking at what the contract is designed to achieve.

The UT held at para 52 that the reason why early termination rights do not stop the contract being within art. 14(2)(b) is because the exercise of a right to terminate the contract early is not a performance of the contract, but a means of avoiding performance. Thus, when asking what are the interests of the parties that performance of the contract satisfies, assume that the contract will be performed, not brought to an early end, even if early termination is lawful rather than a breach of contract.

At para 63, the UT held that the FTT made an error of law in interpreting art 14(2)(b). It is not sufficient for a contract to come within art. 14(2)(b) for it to contain a provision under which the hirer has an option to acquire the ownership of the vehicle at the end of the hire period, and that such acquisition is a normal outcome. In order for a contract to come within art 14(2)(b), it must be the normal outcome of the contract, this being determined by reference to the economic purpose of the contract, that is by looking at the parties’ respective interests which performance of the contract satisfies.

(2) The procedural issue

MBFS unsuccessfully argued that the FTT had proceeded in a procedurally unfair way because the FTT described the Agility agreement in the decision as a contract for sale of goods. This was not an argument that had been advanced by HMRC or anticipated by MBFS; and that it was unfair for the FTT to reach this conclusion without having informed MBFS of its intention to do so and given it an opportunity to address the point (para. 64 of the decision).

At para 71, the UT held that the FTT did not mean that the Agility agreement was a contract for sale as a matter of law. The FTT correctly identified it as a hire purchase agreement; they recognised that the contract gave the customer an option to purchase; and they recognised that as a matter of law the customer was not obliged to exercise the option, so that ownership might not pass. The FTT must have been intending to refer not to the legal characterisation of the contract, but to the economic reality.

(3)  The factual issue

MBFS tried to displace the factual findings of the FTT, in particular its characterisation of the Agility agreement as in effect a contract of sale, where the sole realistic option for the customer was to purchase the vehicle (para 76 of the decision).

The UT held that the Agility agreement cannot be characterised as in effect a contract for sale of the vehicle. It is a contract which may lead to a sale of the vehicle, but equally may not. It is not a contract under which ownership is to pass in the normal course of events.

HMRC did not claim that purchase was the sole realistic option. Rather it claimed that the Agility agreement is a means for a customer to acquire a vehicle: the essence of the agreement, just like the hire purchase contract, is that the customer by making the instalment payments acquires the option to purchase the goods (para 77 of the decision).

Question of choice

One economic interest that the contract serves is the interest of the customer in being able to choose, three years down the line, whether to complete the purchase of the vehicle or whether to forego that opportunity. The fact that about half of the customers do not buy the vehicle shows that this is a real, and not merely theoretical, interest (para 81 of the decision).

The economic interests of MBFS, which the Agility agreement serves, are those of enabling it to provide vehicles to its customers on terms that they will either be purchased, or be returned at no loss to MBFS; at the same time, MBFS receives interest on the finance it provides, with security in the shape of retention of title (para 82 of the decision).

The UT held that the Agility agreement cannot be characterised as in effect a contract for sale of the vehicle.

It is a contract which may lead to a sale of the vehicle, but equally may not

The UT held that the decision of the FTT that the sole realistic option under the agreement was to purchase the vehicle was unsupported by the material referred to by the FTT and was one that no reasonable tribunal, properly directed, could reach.

The true and only reasonable decision from the material before the FTT was that the Agility agreement gave the customer an opportunity to purchase the vehicle, but that it also gave him a genuine (and not illusory) choice as to whether to do so (para 94 and 102 of the decision).

Holding in favour of MBFS, the UT held that the Agility agreement cannot be characterised as in effect a contract for sale of the vehicle. It is a contract which may lead to a sale of the vehicle, but equally may not. It is not a contract under which ownership is to pass in the normal course of events (para. 107 of the decision).

Comment

Apparently, the European Court of Justice has not yet ruled on the interpretation of art 14(2)(b).

If there is a supply of goods on deferred terms under art 14(2)(b), VAT is accountable on the full price of the vehicle at the start of the agreement. However, if there is a supply of services, VAT is accountable only as and when payments are received during the duration of the contract.

Thus, MBFS appealed for cashflow reasons, which in this case involves the timing of the payment of output tax of about £160m relating to approximately one year. This decision agrees with the usual VAT treatment of regular hire purchase deals, including those requiring a significant final (‘balloon’) payment. There may be other consequences in determining whether a supply is of goods or services, eg, in identifying the place of supply.

Stan Dencher is a senior tax writer, CCH www.cch.co.uk