On October 18th 2018, the Court of Justice of the European Union (the “ECJ”) handed down an important ruling (case C-153/17), providing new guidance regarding the deduction of input VAT on general overhead costs in hire purchase transactions.
The dispute at hand involved Volkswagen Financial Services (UK) Ltd ("VWFS"), a financial company offering hire purchase solutions for the purchase of vehicles produced by the Volkswagen AG Group, and Her Majesty's Revenue and Customs (“HMRC”). The hire purchase transactions carried out by VWFS consisted of (i) a VAT taxable supply of a vehicle (at cost) and (ii) a VAT exempt provision of a credit (in consideration for interest, charged to the customer). As regards the input VAT incurred by VWFS in the context of its business, part of it is related only to taxable or exempt supplies, while part of it is related to both types of supplies. The parties disagreed to which extent VWFS should be entitled to deduct this latter input VAT, which is described in the United Kingdom as “residual VAT”.
As a preliminary remark, the ECJ recalled that every transaction must normally be regarded as distinct and independent, without however artificially splitting a single supply from an economic point of view into two or more elements, so as not to distort the functioning of the VAT system. With respect to the hire purchase transactions carried out by VWFS, the ECJ took the view that they consist of several separate supplies, namely the supply of a vehicle on the one hand and the supply of credit on the other hand.
The ECJ thereafter referred to the general principles regarding the right to deduct input VAT and recalled in particular that a taxable person may deduct input VAT on general costs, even where there is no direct and immediate link between a particular input transaction and an output transaction giving rise to the right to deduct, given that general costs, as such, are components of the price of goods and services the taxable person supplies and thus have a direct and immediate link with the taxable person’s economic activity as a whole. In the view of the ECJ, the fact that VWFS had decided to include the costs of its overhead expenses solely in the price of the exempt portion of its transactions (i.e. the interest charged on the credit supply) should have no effect whatsoever.
As VWFS’ general costs concerned goods and services used to effect both transactions giving rise to a right to deduct and transactions not giving rise to such a right, a deductible portion must be established in accordance with the provisions of the Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax (the
“VAT Directive”). As a general rule, the deductible portion is to be determined by reference to turnover. Nevertheless, the VAT Directive allows Member States to apply a different method or allocation, under the condition that the alternative method guarantees a more precise result.
Regarding the hire purchase transactions carried out by VWFS, the ECJ ruled that a method, such as the one selected by HMRC, which did not take account of the initial value of the goods (i.e. the vehicles) concerned when they are supplied, was not capable of ensuring a more precise apportionment of the input VAT than that which would arise from the application of the turnover-based method.
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