For example, if a customer ‘hires’ a sofa for
£20 per week for 24 months and is then given the option
to buy it for a further £320 at the end of this period,
this could be defined as a supply of a good (the sofa) rather
than a service (the leasing agreement).
The [court] held that a leasing contract with an option to
purchase at the end of its term should be a supply of goods
where, given the financial terms of the agreement, exercising
the option is the only economically rational choice
the lessee could make,” said Lee Squires, head of indirect tax
at Hogan Lovells in the UK.
“As an example, the [court] says this would be the case
where the total of the contractual instalments corresponds to
the market value of the asset, including the cost of financing,
and the lessee is not required to pay a substantial additional
sum, i.e. where title passes automatically or on payment of a
Facts of the case
The case concerned a financial product called ‘
Agility’, by Mercedes-Benz Financial Services
(MBFS), a UK-based subsidiary of Daimler. Agility is marketed
as a hire purchase contract agreement, but has low monthly
payments not fully covering the value of the vehicle. The
agreement states that the lessee can then pay 40% of the price
of the vehicle at the end of the lease period, and then becomes
the owner of the vehicle.
UK tax authority HMRC, argued that Agility constituted a
supply of goods within Article 14(2)(b) of the VAT Directive,
as do hire purchase agreements, and claimed a full payment of
VAT when the vehicles were handed over.
MBFS challenged this in the First-tier Tribunal on the
grounds that partaking in an Agility agreement does not
necessarily mean that there will be a transfer of ownership
– and therefore that Agility constitutes a service,
with VAT payments only due on each monthly instalment.
The First-tier Tribunal dismissed the case, and MBFS was
allowed an appeal to the Upper Tribunal. HMRC appealed that
decision in the Court of Appeal, which ultimately referred the
case to the ECJ.
The ECJ ruled, in line with Advocate General Maciej
Szpunar’s Opinion, that: “The words ‘contract
for hire which provides that in the normal course of events
ownership is to pass at the latest upon payment of the final
instalment’ … must be interpreted as
applying to a leasing contract with an option to purchase if it
can be inferred from the financial terms of the contract that
exercising the option appears to be the only economically
rational choice that the lessee will be able to make at the
appropriate time if the contract is performed for its full
term, which it is for the national court to ascertain.
Advantage for taxpayers
Hire purchase contracts are common for financing new and
used car purchases in the UK, so this is a case which could
have quite a wide impact if companies are able to adapt these
agreements to re-categorise them as services rather than
“Overall, this is a pleasing judgment for taxpayers and
welcome news for the car industry at a time of uncertainty,”
said Stuart Walsh of Pinsent Masons.
The cashflow advantages are significant, as companies will
no longer have to account for output VAT for the whole price of
the car upfront. Instead, this can be done in monthly
“If a contract is treated as a supply of goods, all the VAT
due under the contract must be accounted for upfront. A
supplier who thought their contract should be a supply of
services following the MBFS case could potentially
seek a repayment of this VAT and argue they should only account
for VAT periodically on each instalment due under the
contract,” Squires told International Tax Review.
“Generally, the change in classification from goods to
services will only give a cash-flow advantage rather than an
absolute reduction in VAT.”
It’s also possible that some VAT will have been
overpaid by some companies.
As such, the automotive industry and other companies using
hire purchase contracts will need to take note of this ECJ
ruling and plan for the VAT change it creates.
The judgment, though clear, does leave some questions.
“The judgment leaves some uncertainties, particularly in
relation to contracts with substantial balloon payments that
are (or expected to be) lower than the market value of the
asset at the end of the lease,” said Squires. “There might be
argument over whether the only economically rational course of
action is to exercise the purchase option in these cases. The
Advocate General’s opinion suggested that exercise of the
option would not be the only rational course in such a
In the case of Agility, the final payment made by consumers
was 40%. There is also uncertainty over what proportion this
must be – using the example of the sofa, the final
payment is 40% of the total value of the sofa. If the final
payment was just £160, would this still count as a supply
of a service?
The UK is looking to leave not just the EU, but the
jurisdiction of the ECJ. Countries such as Switzerland and
Norway are still bound by its judgments, but UK Prime Minister
Theresa May believes that the public voted, in the referendum
of June 23 2016, to be free of the reach of laws and judgments
“Following Brexit, it’s likely that the UK will have more
flexibility to legislate to change the UK’s VAT rules if it
chooses to do so,” said Squires. “Although, pre-Brexit [ECJ]
decisions will remain binding in the absence of legislative