Revenue and Customs Brief 31/07
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Issued 30 March 2007
VAT: Partial Exemption VAT recovery on overhead costs relating to supplies
of hire purchase
This article explains HMRC’s policy on attributing VAT on overhead costs to
supplies made under hire-purchase (HP) agreements. It affects businesses that
make supplies under HP agreements to consumers, but does not apply to those who
arrange such supplies and receive a commission. HMRC is aware that policy is not
being applied consistently, so this article confirms the policy to be applied
from 1 April 2007. This article also refers to the Tribunal decision Royal Bank
of Scotland [VTD 19983] regarding VAT recovery and HP agreements.
Background to VAT recovery
An HP transaction involves the supply of goods on credit terms. Provided the
charge for credit is clearly identified to the customer, an HP transaction is
treated as two supplies for VAT purposes, comprising:
- a supply of goods which is subject to VAT; and,
- a supply of credit which is exempt from VAT.
Businesses making both taxable and exempt supplies must apply a partial
exemption method to apportion VAT on overhead costs (such as lighting and
heating) to recover that VAT to the extent that the costs are ‘used’ for making
The European Court of Justice (ECJ) has established the principles that apply
to the recovery of input tax and the Court of Appeal in Dial-a-phone ( STC
987) confirmed that these principles also applied in UK law.
Costs are therefore ‘used’ to make taxable supplies of goods or services
within the meaning of the partial exemption regulations, if they:
- have a direct and immediate link with the taxable transaction (see BLP
- are borne directly by the cost components of a taxable transaction (see
Midland Bank plc case C-98/98);
- are costs of the various components of the price (see DA and EA Rompelman
These are different aspects of a single test to determine whether VAT is
In applying these ECJ principles, HMRC’s view is that in order for costs to
be a cost component of a taxable transaction, the costs should normally be
reflected in the selling price of the taxable transaction. In other words, there
is an objective test for determining VAT recovery, in that VAT on costs is not
recoverable unless the costs are reflected in the selling price of the taxable
VAT recovery for HP transactions
Normally it is clear when VAT on costs is recoverable. This is because goods
and services are either sold independently, each priced to reflect the costs
incurred, or if they are supplied together, the price of each item reflects both
direct costs and overheads.
In most HP transactions, the goods are resold at cost without any margin to
cover overhead costs. As there is no margin on the HP goods, the cost of the
overheads will normally be built into the price of the supply of credit. In this
scenario, HMRC’s view is that the overheads are purely cost components of the
exempt supply. Otherwise the business would continually enjoy net VAT refunds
- making no zero-rated or reduced rate supplies; and
- charging a total consideration under the HP agreement that fully recovers
its costs and an element of profit.
Where overheads are used to make both HP transactions and other supplies on
which VAT is charged (such as taxable purchase option fees or sales of
repossessed goods), then some VAT on overhead costs is recoverable. In this
scenario the partial exemption method should reflect the extent to which the
overhead costs are a cost component of the prices of the supplies in question.
Businesses using special methods will need to review them to ensure that they
are fair and reasonable in accordance with the above principles. If an existing
method is not fair and reasonable, the business concerned should contact HMRC to
discuss a new method going forward. In approving new methods, or reviewing
existing methods, HMRC will ensure that methods fairly attribute VAT to taxable
supplies taking account of this article.
HP businesses using the standard method will need to consider the standard
method override provisions and, if necessary, apply for a special method. In
doing this the above principles for HP transactions will need to be taken into
account. Further guidance is available in VAT Notice 706 Partial exemption.
Royal Bank of Scotland
In February, the Scottish Tribunal released its decision in the Royal Bank of
Scotland (RBS) case regarding VAT recovery and HP transactions. RBS appealed
HMRC’s refusal to approve a replacement partial exemption method in which HP
transactions would be treated as two transactions, one taxable and one exempt
such that 50% of the VAT on related overhead costs would be recoverable. The
Tribunal found for RBS. HMRC has lodged an appeal to the Court of Session. The
cost component point was not tested because the appeal predated this Revenue and
About the Author
© Crown Copyright 2007.
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Article Published/Sorted/Amended on Scopulus 2007-03-30 22:04:44 in Tax Articles