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ECJ Guidance on the VAT treatment of Leases

A recent VAT case in the European Court Justice is of considerable interest to motor-vehicle financiers because it blurs the long established distinction between the VAT treatment of lease and hire purchase.

Hire purchase is generally regarded as a supply of goods for which VAT is payable at the outset on delivery, whereas a lease is treated as a supply of services for which VAT is accountable only at the point of payment of each periodic instalment. Thus lease is regarded as providing a real cash flow benefit to the user.

In recent years a number of interesting hybrid products have appeared in the motor vehicle finance market, one of which is the Agility product offered by Mercedes-Benz. This is some way between a typical hire purchase agreement and a lease in that instalments represent approximately 60% of the sale price plus financing costs, with an option to purchase of approximately 40% of the sale price. This was intended to represent the estimated average residual value of the vehicle at contract maturity, and on average the option is exercised by 50% of users.

Mercedes-Benz contended that the Agility product was a supply of services and therefore a lease for VAT purposes, whilst HMRC regarded it as a supply of goods and therefore to be treated as hire purchase.

The dispute was referred by the Court of Appeal to the ECJ and on 4 October 2017 in HMRC v Mercedes-Benz Financial Services UK Ltd (C-164/16) the ECJ agreed with Mercedes-Benz.

The ECJ has held that leasing arrangements with an option to purchase constitute a supply of goods for VAT purposes only if transfer of ownership had to follow “in the normal course of events”, including it being the only economically rational course for the lessee. Otherwise the arrangement will be a supply of services.

The case has now been referred back to the Court of Appeal but it seems inevitable that Mercedes-Benz will now succeed in its interpretation of the VAT treatment of the Agility product.


This decision may well lead to the introduction of further hybrid models into motor-vehicle financing and its consequences may even extend more generally into the asset finance market.

It is also worth remembering that the FCA announced in its 2017/18 business plan that it was looking at the motor finance market to develop its understanding of the market and assess whether it was functioning as well as it could, and one of the points made by the FCA was a concern about the potentially confusing terminology used in describing the various products available.