The VAT treatment of PCP contracts has changed following a European Court of Justice decision, in relation to Mercedes Benz Financial Services (MBFS).

In broad terms a PCP contract is one where the customer pays a series of lease payments followed by an optional balloon payment to acquire the asset, or they can simply return the asset at the end of the hire period.

Historically PCP and similar contracts were viewed by HMRC as a supply of goods and a separate supply of credit. Now, in some cases, such contracts are considered to be a single supply of taxable leasing services.

A traditional hire purchase (HP) agreement is similar, except that the balloon payment is not optional. Such agreements usually have a much lower ‘option fee’ to acquire the asset, payable alongside or immediately after the balloon payment.

Where the option fee is clearly below the anticipated market value, HP contracts involve a supply of goods on which VAT is due at the outset, and a separate supply of VAT exempt finance. For PCP contracts, the correct VAT treatment depends on the level at which the optional balloon payment is set and what a customer, acting as a ‘rational economic actor’ would do when entitled to exercise a purchase option.

If the balloon payment is set below the anticipated market value, such that a rational customer would be expected to buy the asset at the end of the contract term, to potentially benefit from a profit on sale, the PCP agreement would be treated in the same way as an HP contract, i.e. as a supply of goods and separate supply of finance.

If, instead, the balloon payment is set at or above the anticipated market value at the end of the hire, the VAT treatment follows the MBFS judgement. It is a supply of leasing services from the outset and VAT must be accounted for on each instalment. There is no advance or credit, so it follows that there is no finance.

Where a supplier has to change the VAT treatment of their contracts you may be required to adjust the VAT you have reclaimed. It is also important to ensure you clarify the correct VAT treatment of future finance agreements, and hold VAT invoices to support any VAT reclaimed to avoid any potential problems. In the case of cars ,whether a PCP contract is a supply of goods or a hire contract may have implications for VAT recovery.

Should you require any help or assistance with anything I’ve raised, please don’t hesitate to get in touch.

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