In June 2008, HMRC assessed Volkswagen Financial Services Ltd (VWFS) for £498,866 in relation to how it had recognised hire purchase transactions in its partial exemption special method (PESM). In HMRC’s view, if a finance house like VWFS sold a car for £15k on a three-year HP deal at 5% APR, then it should recognise the interest and ancillary charges (some of which were subject to VAT) in its PESM, but it should exclude the £15k. VWFS bought the car for £15k from the VW dealer, and sold it for £15k to the customer. Crudely, there was no ‘added value’ which could support VWFS’ overhead costs, and those costs should therefore be principally attributed to the VAT-exempt interest income.
Almost ten years later, and after four rounds of litigation, the Supreme Court has decided ([2017] UKSC 26, reported at page 5) that guidance is needed from the CJEU in order to rule on HMRC’s approach. According to the Supreme Court’s press release the questions to be referred to the European Court will include: ‘where general overhead costs attributed to HP transactions … have been incorporated only into the price of the taxable person’s exempt supplies of finance, does the taxable person have a right to deduct any of the input tax on those costs?’
(Typically, it takes around 18 months from a reference being made for the CJEU to deliver a judgment. Therefore, there is a reasonable chance of the Supreme Court receiving an answer before the UK leaves the EU).
Although finance houses typically make no profit on the sale of a car on HP, they have responsibilities towards purchasers (as shown, for example, by the fact that cars can be returned to them halfway through a deal). Against that background, HMRC’s expectation that the cars should simply be disregarded appears difficult to accept.
The alternative transaction count method suggested by VWFS, which gave equal weighting to the finance and vehicle supply elements of each transaction (i.e. 50% residual input tax recovery) might be simple to operate, but would also arguably fail to reflect the complexity of what a finance house does. It would be much more favourable to finance houses than the 15% recovery that was historically applied by many taxpayers under a method agreed with the Finance Houses Association (but which was withdrawn in 2000). HMRC would probably be on stronger ground if the proceedings were testing the validity of the transaction count method, rather than focusing on whether HMRC’s ‘value-added’ approach can be justified.
How, then, is this issue likely to be resolved, if neither of the methods advanced by the parties are considered to fairly reflect how input tax is used? Will there be a wider impact for other taxpayers?
If the CJEU were to endorse HMRC’s reasoning, then it could potentially impact any business which operates a linked pricing model. Should mobile phone operators ignore handset sales; or video game makers disregard sales of consoles; or printer manufacturers recognise sales of ink, but not printers? HMRC’s interest in this area was seen in 2008 in Camden Motors, when they argued that car dealers were largely in business in order to generate finance and insurance commissions rather than to sell cars. That case ended in defeat for HMRC at the First-tier Tribunal, but if HMRC’s ‘value-added’ approach to partial exemption is endorsed by the Supreme Court and CJEU in VWFS, then there is a clear risk that similar challenges will reappear in other industry areas.
If the CJEU rejects HMRC’s theory, then it might mean that VWFS enjoys 50% recovery for some historical VAT quarters, but it will not necessarily provide a template for other finance houses. HMRC appear to have made a strategic error in VWFS, in advancing their preferred argument that car sales should be excluded without putting forward any appropriate alternatives. Such alternatives will, however, need to be considered by all other finance houses which have been unable to recover input tax on overheads over the last decade, but have been submitting claims to protect their positions.
Whatever the eventual outcome of the litigation, it therefore seems that agreement over what proportion of residual input tax finance houses should recover is still some years off.
In June 2008, HMRC assessed Volkswagen Financial Services Ltd (VWFS) for £498,866 in relation to how it had recognised hire purchase transactions in its partial exemption special method (PESM). In HMRC’s view, if a finance house like VWFS sold a car for £15k on a three-year HP deal at 5% APR, then it should recognise the interest and ancillary charges (some of which were subject to VAT) in its PESM, but it should exclude the £15k. VWFS bought the car for £15k from the VW dealer, and sold it for £15k to the customer. Crudely, there was no ‘added value’ which could support VWFS’ overhead costs, and those costs should therefore be principally attributed to the VAT-exempt interest income.
Almost ten years later, and after four rounds of litigation, the Supreme Court has decided ([2017] UKSC 26, reported at page 5) that guidance is needed from the CJEU in order to rule on HMRC’s approach. According to the Supreme Court’s press release the questions to be referred to the European Court will include: ‘where general overhead costs attributed to HP transactions … have been incorporated only into the price of the taxable person’s exempt supplies of finance, does the taxable person have a right to deduct any of the input tax on those costs?’
(Typically, it takes around 18 months from a reference being made for the CJEU to deliver a judgment. Therefore, there is a reasonable chance of the Supreme Court receiving an answer before the UK leaves the EU).
Although finance houses typically make no profit on the sale of a car on HP, they have responsibilities towards purchasers (as shown, for example, by the fact that cars can be returned to them halfway through a deal). Against that background, HMRC’s expectation that the cars should simply be disregarded appears difficult to accept.
The alternative transaction count method suggested by VWFS, which gave equal weighting to the finance and vehicle supply elements of each transaction (i.e. 50% residual input tax recovery) might be simple to operate, but would also arguably fail to reflect the complexity of what a finance house does. It would be much more favourable to finance houses than the 15% recovery that was historically applied by many taxpayers under a method agreed with the Finance Houses Association (but which was withdrawn in 2000). HMRC would probably be on stronger ground if the proceedings were testing the validity of the transaction count method, rather than focusing on whether HMRC’s ‘value-added’ approach can be justified.
How, then, is this issue likely to be resolved, if neither of the methods advanced by the parties are considered to fairly reflect how input tax is used? Will there be a wider impact for other taxpayers?
If the CJEU were to endorse HMRC’s reasoning, then it could potentially impact any business which operates a linked pricing model. Should mobile phone operators ignore handset sales; or video game makers disregard sales of consoles; or printer manufacturers recognise sales of ink, but not printers? HMRC’s interest in this area was seen in 2008 in Camden Motors, when they argued that car dealers were largely in business in order to generate finance and insurance commissions rather than to sell cars. That case ended in defeat for HMRC at the First-tier Tribunal, but if HMRC’s ‘value-added’ approach to partial exemption is endorsed by the Supreme Court and CJEU in VWFS, then there is a clear risk that similar challenges will reappear in other industry areas.
If the CJEU rejects HMRC’s theory, then it might mean that VWFS enjoys 50% recovery for some historical VAT quarters, but it will not necessarily provide a template for other finance houses. HMRC appear to have made a strategic error in VWFS, in advancing their preferred argument that car sales should be excluded without putting forward any appropriate alternatives. Such alternatives will, however, need to be considered by all other finance houses which have been unable to recover input tax on overheads over the last decade, but have been submitting claims to protect their positions.
Whatever the eventual outcome of the litigation, it therefore seems that agreement over what proportion of residual input tax finance houses should recover is still some years off.
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