A Personal Contract Purchase (PCP) used to be straightforward from a VAT perspective: it was generally treated as a supply of goods, with VAT due in full at the outset, while the finance element was exempt.
That position changed following the 2017 Court of Justice of the European Union (CJEU) decision in Mercedes-Benz Financial Services (MBFS), which opened the door to alternative VAT treatments.
In response, HMRC issued updated guidance in February 2019 to clarify how UK businesses should apply the judgment in practice. Yet even today, the VAT treatment of PCP and similar contracts continues to cause uncertainty.
If you are taking out a PCP, it is essential to know how VAT has been applied and whether this is correct. Getting it wrong can affect the overall cost of the contract – either paying too much VAT upfront or too little on your monthly payments. For business buyers, this could also mean reclaiming the wrong amount of VAT, leading to errors on your VAT returns.
How is VAT treated on PCP agreements?
The VAT treatment of a Personal Contract Purchase (PCP) depends on the type of agreement and, importantly, the level of the final optional payment – in other words, whether you are expected to buy the car or return it at the end of the contract.
Supply of goods
- You are expected to buy the car at the end ‘exercise the option’;
- VAT is charged and recoverable in full at the start of the agreement, based on the vehicle’s total price;
- The VAT should be shown as a single lump sum on the invoice or finance agreement, payable upfront; and
- Monthly finance payments are then shown net of VAT (no VAT charged on instalments).
Supply of leasing services
- You are expected to return the car at the end of the contract;
- The VAT is chargeable and recoverable on each periodic payment; and
- A VAT schedule should be provided by the finance company detailing these payments.
How to know if the VAT treatment is correct
The key question: Is the final optional payment set at a level that makes it likely you will buy the car, or return it?
Typically, a PCP involves:
- An initial deposit,
- Monthly payments covering depreciation, and
- A final option to either:
– Pay a lump sum (“balloon payment”) to buy the car,
– Return the car, or
– Trade it in.
The VAT treatment hinges on what a reasonable buyer’s likely choice would be – to return the car or trade it in – and to establish this we need to look at the level of the final optional payment. This determines whether the contract is treated as a supply of goods or a supply of services, each with its own VAT implications.
- At/above anticipated market value = you are likely to return the car = supply of leasing services = VAT should be applied on each monthly payment.
- Below anticipated market value = you are likely to buy the car = supply of goods with a separate supply of finance = VAT is due on the supply of goods in full at the outset of the contract, the finance is exempt from VAT.
HMRC will generally accept that the optional payment is set below the anticipated market value if it is below the value expected based on historical depreciation rates in immediately preceding years for the same or similar assets, such as the same model of car.
What you can do as a buyer
- Check your finance agreement or invoice for how VAT has been applied;
- Ask how the final payment amount has been calculated; and
- Ask for a VAT schedule from your finance company if the treatment is unclear.
Correcting errors
If the VAT has not been correctly applied, adjustments should follow the normal error correction procedures.
This may affect both output VAT (charged) and input VAT (recoverable), so it is worth checking early to avoid future complications.
How M+A Partners can help
VAT is a complex area that requires careful planning. We are experienced in all aspects of VAT and can assist with any stage of the returns process.
If you need advice or support on the VAT treatment of PCP or similar contracts, get in touch with our specialist below.
