Following the recent reinterpretation by the European Court of Justice (ECJ) of the definition of closed-end finance leasing, a new Advocate General (AG) opinion has exploded another “VAT bomb” in relation to current practice. For many years, leasing companies have divided the fees payable under finance lease contracts into a VATable and a non-VATable part, but the latest AG opinion states that the whole lease fee should be liable for VAT in its integrity. This could have serious implications for the Hungarian leasing market too, so it is worth keeping an eye on how the case progresses.
Given that finance leasing has long been a predominant means of financing in European economies, there is a surprising amount of uncertainty regarding its VAT treatment. The status quo was first upset by an ECJ ruling in 2012, which was reinforced last year by the judgment passed in the case of Mercedes-Benz Financial Services. Based on this, all finance lease transactions should be treated as “closed-end”, in other words a sale of goods, although in its practice the Hungarian tax authority has previously treated them unequivocally as being “open-end”; that is, a provision of services.
Last week, however, the AG exploded the next “VAT bomb” in relation to lease transactions. In his opinion, the AG expresses the view that splitting the lease fee into a VATable principal part and a non-VATable interest part conflicts with the EU VAT rules. This is because, in the AG opinion, such a division is artificial and the entire lease fee should be liable for VAT. The AG’s opinion is not binding on the ECJ. Nevertheless the opinion, articulated in relation to UK practice, is still convincing enough for us to take it seriously, and to keep a watchful eye on the Court’s forthcoming ruling to be passed in the same case.
What is the Hungarian practice?
The Hungarian practice for the treatment of finance leasing is defined in a 2008 tax authority guidance. According to this, finance leasing is a complex transaction that comprises both sales and financing elements. In line with the tax authority guidance, the market usually divides such transactions into a VATable sale and non-VATable lending part.
What exactly does the AG say?
The AG based his opinion on the EU practice whereby it is not possible to artificially break transactions down into elements merely because the fees payable for them are stated separately on the invoice or in the agreement between the parties. And in the case of a lease transaction – argues the AG – the lessee’s aim is not to take out a loan on the one hand, and acquire the leased object on the other. His aim is exclusively to use and obtain the product, together with all the other services that are usually associated with a finance lease. In view of this, the AG regards as artificial the practice applied both in Hungary and in the United Kingdom, for example, whereby the lease fee is divided into a VATable principal part and a non-VATable interest part.
It should be borne in mind that, with this opinion, the AG is in disagreement not only with the United Kingdom, but also with the European Commission; so it should not be taken as read that this opinion will also be shared by the ECJ. What is more, due to certain procedural considerations, there is even a possibility that the Court will not consider itself competent to decide on this matter.
Nevertheless, knowing the ECJ practice relating to complex transactions to date, the AG opinion does not appear to be at all frivolous. You could certainly say that there is method in its madness.
What can we expect now?
If the ECJ were to adopt the AG opinion, this would have two important consequences. Firstly, the whole of the lease fee would become liable for VAT. This would be unlikely to result in an actual increase in the costs of business-to-business transactions, as the lessees in this case can usually deduct the VAT. However, if the lessee is a private individual, extending the VAT liability to include the financing part is likely to increase the lease fee.
On the flipside, however, if the AG opinion is accepted, the leasing companies would be entitled to deduct VAT in respect of their entire activity, which would effectively enable them to reclaim all of their input VAT. This, in turn, would represent a saving for them.
Based on the above, therefore, it is worth following this case closely, and leasing companies, in particular, should prepare in advance for the possibility that the ECJ might take the AG opinion on board.