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Revenue and Customs Brief 31/07


HM Revenue and Customs -Tax Authorities

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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 taxable supplies.

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 ([2004] 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 case C-4/94);
  • 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 case C-268/83).

These are different aspects of a single test to determine whether VAT is recoverable.

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 supply.

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 despite:

  • 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.

Existing methods

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 Customs Brief.

About the Author

© Crown Copyright 2007.

A licence is need to reproduce this article and has been republished for educational / informational purposes only. Article reproduced by permission of HM Revenue & Customs under the terms of a Click-Use Licence. Tax briefs are updated regularly and may be out of date at time of reading.

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Article Published/Sorted/Amended on Scopulus 2007-03-30 22:04:44 in Tax Articles

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