Commissions for Her Majesty's Revenue & Customs .v. Mercedes-Benz Financial Services UK Ltd

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Case c-164/16 (Request for preliminary ruling from the Court of Appeal) Opinion of Advocate General.  

The Advocate General has provided his opinion in HMRC v. MBFS that only leasing transactions offering certainty that ownership will pass on expiry of the agreement term will be classified a supply of goods for VAT purposes.

The circumstances in this case were that MBFS offered financial products relating to the use and acquisition of vehicles. It offered three standard types of vehicle-use agreements: leasing, hire purchase and a mixed agreement called 'Agility'. The case concerned the classification of the Agility agreement for VAT purposes; was it a supply of goods requiring payment of VAT upfront on the full purchase price or, was it a supply of services with VAT payable only on each rental.

Under the Agility agreement lessees paid rentals for use during the lease period and had the option to purchase the vehicle at the end of the agreement term. However the transfer of ownership was subject not only to a nominal option fee (as per standard HP), but also a final voluntary  rental representing the anticipated residual disposal value of the vehicle at the end of the lease period. MBFS confirmed this amount could vary from 42% to 48% of the initial price.

HMRC provided a tax ruling that such agreements are a supply of goods, so that output VAT would be due on the full value of the supply at the outset of the lease, in the same way as for standard HP structures. MBFS contended that the Agility structure should be treated as a lease unless/until the optional final rental was paid, at which stage only it should be treated as a supply of goods

Given the obvious tax implications for this and other similar PCP structures, the dispute ended up in the Court of Appeal, which stayed the proceedings and referred the following questions to the Court of Justice for a preliminary ruling:

1. Could an agreement containing an option to purchase be "a contract …which provides that in the normal course of events ownership is to pass at the latest upon payment of the final instalment", for the purposes of Article 14(2)(b) ?

2. If so, does the phrase "in the normal course of events" require a tax authority to do more than to identify the existence of an option to purchase before Article 14(2)(b) will apply?

On 31st May 2017, AG Spuznar delivered his opinion as to when, and in what circumstances, a leasing agreement with an option to purchase following expiry of the term will be a supply of goods under Article 14(2)(b) of Directive 2006/112.

The AG held that in his view, an option to purchase a leased asset would be a transfer of ownership clause for the purposes of  Article 14(2)(b) if the transfer of ownership would take place in the normal course of events. When considering "the normal course of events", it was the AG's opinion that there must be a high degree of certainty that the option will be exercised and title will pass. Therefore, where a lessee has a genuine economically rational choice not to exercise an option to purchase, this will not be covered by Article 14(2)(b) and will not be a supply of goods.

The AG went on to confirm that when considering if the exercise of an option to purchase would have a high degree of certainty, a contrast should be drawn between cases where a lessee is contractually bound to pay rentals throughout the term of the agreement  which substantially correspond with the full purchase price of the asset, and cases where a lessee is only bound to pay instalments which do not substantially correspond with that purchase price. It would not be economically rational for an individual who was effectively bound to pay the full purchase price of the asset over the duration of the agreement not to then exercise the option to purchase for a nominal fee; accordingly, exercise of the option in such circumstances is a virtual certainty. On the other hand, if the instalments do not correspond with the full purchase price, such that the exercise of the option to purchase would require a large payment to be made by the lessee, then in the absence of other relevant circumstances (for example, if the asset is essential for continuation of a business carried on by the lessee), the exercise of the option to purchase will necessarily depend upon circumstances applying at the time. In other words, the lessee can only make a genuine choice as to whether to exercise the option at the end of the rental period, and there can be no certainty at the outset that the purchase of the asset will be part of the normal performance of the agreement.

Based on the AG's opinion, MBFS's Agility agreements are a supply of services, not a supply of goods within the meaning of Article 14(2)(b), so that VAT is due on each rental paid, rather than up front on the full purchase price. It will be appreciated that if this opinion is followed by the Court of Justice, it could have substantial implications for the leasing market. Similar PCP structures are now commonplace in vehicle finance. In addition, the potential VAT/cash flow benefits could also lead to such mixed nature agreements becoming more widely used in other markets, such as equipment finance.

Whether the Court of Justice follows the AG's opinion is yet to be seen; such opinions are not strictly binding but are in practice followed in the majority of cases. Additionally, in the past the Court of Justice has considered numerous cases concerning leasing agreements and their classification for VAT purposes, but has not previously provided clear guidance on the classification of mixed nature transactions. As such, the AG's opinion offers the Court an opportunity to provide such guidance to taxpayers in this complex area. Accordingly, it is likely the opinion will be followed.