Lease Agreements and VAT – falling to be treated as a supply of goods or service?
On 4 October 2017, the Court of Justice of the European Union (CJEU) released its judgment in the case C-164/16 „Mercedes Benz Financial Services UK Ltd.”, concerning the criteria for determination whether a lease agreement falls to be treated as a supply of goods or services for VAT purposes. The fact that purchase of the car is optional in formal terms is not, according to the CJEU, sufficient for treating a leasing product as a supply of service.
The company Mercedes‑Benz Financial Services UK offers three types of leasing products. Leasing based on the first type of agreement excludes any transfer of ownership to the vehicle and is treated as a supply of service. The second type of agreement contains a clause relating to the transfer of ownership, whereby the ownership of the goods is acquired by the lessee automatically if performance of the contract proceeds normally, over the full term of the contract. The company treats this product as a supply of goods.
The third type of agreement, which allows customers to postpone choosing between leasing and purchase until after the vehicle has been handed over to the lessee, became the subject of the dispute.
Subject of the dispute – leasing contract with an option to purchase
CJEU was dealing with a question whether Article 14 (1) Letter b) of the EU VAT Directive, stating that the actual handing over of goods pursuant to a contract for the hire of goods for a certain period, or for the sale of goods on deferred terms, which provides that in the normal course of events ownership is to pass at the latest upon payment of the final instalment is considered as a supply of goods, is to be interpreted as applying to a leasing contract with an option to purchase.
According to SDEU, the above mentioned Article of the EU VAT Directive is applicable if:
the lease agreement contains a clause expressly relating to the transfer of ownership of the goods from the lessor to the lessee, and
it is clear from the terms of the contract, as objectively assessed, that ownership of the goods is intended to be acquired automatically by the lessee if performance of the contract proceeds normally, over the full term of the contract.
The first condition can be viewed as satisfied where the agreement contains an option to purchase the leased asset.
CJEU argues that the second condition is not met where the contract contains an option either to acquire the goods, or to return them to the lessor, or to extend the lease. Such types of leasing products with an option to purchase should in general be considered as a supply of service. However, CJEU has pointed out exceptions from such treatment and mentioned conditions under which handing over of the vehicle to the lessee, based on a lease agreement with an option to purchase, should be treated as a supply of goods. The conditions are as follows:
the aggregate of the contractual instalments will correspond to the market value of the goods, including the cost of financing, and
the lessee will not be required, as a result of exercising the option, to pay a substantial additional sum.
In other words, handing over of the vehicle based on a lease agreement, from whose financial terms it can be inferred that exercising the option to purchase appears to be the only economically rational choice that the lessee will be able to make, should be treated as a supply of goods. Under such circumstances, a lease agreement does not fall to be treated as a supply of service.
According to the relevant provisions of the Slovak VAT Act, handing over of the goods to the lessee based on a lease agreement under which the lessee is obliged to acquire ownership title to the goods, at the latest upon the payment of the last installment, is treated as a supply of goods. If an option to purchase the goods is agreed between the contractual parties, the leasing product should be, under the currently applied interpretation, considered as a supply of service. When assessing the VAT implications of particular lease agreements, it is necessary to consider potential impact of additional conditions set out in the respective CJEU judgment.