VAT on Hire-Purchase Agreements with Balloons

Under a hire agreement, which constitutes the supply of ‘services’, VAT is payable on each monthly instalment, whereas under an ordinary hire-purchase agreement, which constitutes the supply of ‘goods’, VAT is chargeable upon the handing over of the goods at the end of the term, the taxable amount being the total price of the supply. In both cases, the VAT obligations derive from Council Directive 2006/112/EC (“the VAT Directive”).

In HMRC v Mercedes-Benz Financial Services UK (Case C-164/16), the CJEU was asked to make a preliminary ruling on the classification of an ‘Agility’ Agreement, which featured a substantial balloon payment at the end of the term, rather than a modest option fee. Under the finance company’s ordinary hire-purchase agreement, the price of the vehicle (including finance) was represented by the aggregate of the monthly payments, whereas under its ‘Agility’ Agreement, 40% of that price was reflected in the balloon payment. The balloon payment represented the residual value of the vehicle at the end of the term.

The finance company argued that its ‘Agility’ Agreement was an agreement for the supply of services (similar to a hire agreement), as it did not necessarily provide for a transfer of ownership and, indeed, around half of its lessees chose not to make the balloon payment. On this analysis, VAT should only be payable upon the monthly instalments.

HMRC contended that the ‘Agility’ Agreement was a contract for the supply of goods as, for the purposes of art 14 of the VAT Directive, the contract provided that “in the normal course of events ownership is to pass at the latest upon payment of the final instalment”.

The CJEU rejected HMRC’s arguments. In order to be a contract for the supply of goods within art 14, it must be clear from the contractual terms that “ownership of the goods is intended to be acquired automatically by the lessee if performance of the contract proceeds normally, over the full term” (at [34]). This contractually determined outcome (of transfer of ownership) is “incompatible with a genuine economic alternative for the lessee” (at [37]). Where, as here, the lessee has a genuine option not to exercise the option to purchase at the end of the term, it is a contract for the supply of services. It followed that VAT was only payable upon the monthly instalments.

On the other hand, a hire-purchase agreement would be an agreement for the supply of goods where exercising the option to purchase was the only economically rational choice, e.g. because the aggregate of instalments already paid corresponded to the total cost of purchasing the goods on finance. In such cases VAT was payable at the end of the term, charged upon the total cost of the supply.