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Several aspects of the tax treatment of lease transactions in the new VAT system have been clarified

Contact: Kinga Tihanyi
Deloitte in Hungary
Marketing Manager
+36 1 428 6634

Budapest, 4 September 2008  - The gap-filling guidelines recently issued by the Ministry of Finance and Tax and Financial Control Administration on the VAT treatment of lease transactions contain a clear position regarding several issues that were ambiguous under the new VAT Act. While in addition to rules pertaining to lease transactions, several conclusions may be drawn on the general interpretation of the amended regulation, the guidelines fail to elaborate on certain important taxation issues. – Deloitte notes.  Such neglected issues are the tax implications of the termination or transfer of lease contracts - in these areas a new position is expected to be issued in response to the joint initiative of the Lease Association and Deloitte.

Veszprémi István, a partner at Deloitte Ltd's Tax function explained: In its position the tax authority provides a brief review on the effective Hungarian regulations and practice regarding lease transactions as atypical contracts, while – in a very progressive manner – covers the concept of the operating lease as well. The starting point for the tax authority in its review is that since 'lease' is not designated as such in the VAT Act, the VAT treatment of lease transactions depends on their content – he added.

Tax treatment of financial lease transactions
The Deloitte expert emphasised that the partial service involved in the financial lease which is similar to a crediting or loan relationship is subject to tax exemption without a VAT deduction right, provided that the loan transaction may clearly be separated from the base transaction. For this, however, several criteria must be met simultaneously: the parties should agree separately on the consideration for the base transaction and the loan transaction upon concluding the contract; the interest rate should be laid down in the loan agreement; and the considerations for the two transactions (base and loan transactions) should also be settled separately.

Veszprémi István added: With respect to closed-end finance leases it should be noted that the date of performance is the date of transfer into the lessee's ownership under the amended VAT Act. Accordingly, similarly to previous regulations, the VAT payment obligation is incurred at the lessor with respect to the full principal amount upon the transfer of possession. Naturally an invoice shall be issued of the above, however, further lease fees to be paid are not subject to value added tax – he explained.

The Deloitte expert said: In a closed-end finance lease, the tax base – according to the basic rule – is the consideration expressed in money value that the beneficiary receives or is to receive either from the purchaser or a third party. However, amounts received under accountability (e.g. registration tax paid instead of the lessee, the insurance premium paid by the lessor under the insurance policy taken out by the lessee) do not constitute part of the tax base.

Veszprémi István added: In case of auxiliary costs it should be considered whether they are built in the tax base of the base transaction or the tax exempt loan transaction. The position only provides guidance in this respect: costs associated with the subject of the lease (e.g. environmental product charge on the leased product, customs, duties, fuel card expenses, storage fee, motorway toll) constitute the tax base of the supply of goods or services.

The Deloitte expert emphasised: The guidelines pay special attention to the appropriate VAT treatment of insurance premium and agents' commission. The VAT treatment of the insurance premium depends on the title and manner of its payment, i.e. it may constitute the tax base of either the base or the loan transaction, or may even qualify as an individual transaction. In case of the agent's commission, the primary criterion is whether the agent merely intermediates the lending service - since in this case such intermediation is tax exempt - or he is the one who sells the product as well. This latter case requires further analysis – Veszprémi István warned. If the date of the sale of goods and lending are the same, the lending service qualifies as an auxiliary cost related to the supply of goods, and constitutes the latter's tax base, while the related VAT is deductible by the lessor. If, however the two dates are different, the lending service shall be regarded as an independent service and, accordingly, is tax free – Mr. Veszprémi explained.

In case of an open-end finance lease, both the base transaction and the related financial service shall qualify as the supply of services. Pursuant to the effective VAT Act, an open-end finance lease qualifies as letting out; therefore tax payment obligation is incurred when the individual lease payments are due, i.e. in all cases invoices must be issued on the payment of the lease fee, where the fee is to be broken down to principal and interest - the Deloitte tax partner said.

Operating Leases
Kelemen László, manager at Deloitte's Tax function told us: rules of a finance lease shall be applied to the operating lease with the modification that in an operating lease there is no transaction of a financial nature that would be tax exempt, i.e. the service provided in case of an operating lease is fully taxable provided that the letting of the given leasehold is subject to VAT – the expert said.

Nevertheless, the fulfillment of the tax payment obligation in this case may be determined similarly to the open-end lease. The auxiliary services in this case constitute the tax base of the lease; therefore the tax implications of the lease will apply in their case.  Amounts received under accountability, and costs incurred in relation to the operating lease at the lessor or in the   name and to the benefit of the lessee do not constitute part of the tax base in case of the operating lease either.

Tax deduction right related to the purchase of the product subject to lease
Kelemen László added: The guidelines also contain detailed provisions on itemised deduction prohibitions related to passenger cars and residential property in lease transactions as well as for exceptions. Pre-charged tax on these products is deductible if the product is subject to reselling, or if the taxpayer utilises the product or a dominant part thereof by renting it out. The certification of the fact that the passenger car and residential property is utilised by renting out at least a dominant part thereof in a taxable manner requires that the taxpayer keeps separate records.

The Deloitte expert reminded: Under these rules, upon the financial lease or renting out of a passenger car or residential property, the lessor is entitled to deduct pre-charged taxes. Kelemen László emphasised that in relation to tax deduction rights, the guidelines separately provide for non-separable costs incurred at lease companies, which may be deducted proportionately as prescribed by the VAT Act on the deduction of pre-charged taxes. This applies for public utility fees and administrative costs, which serve the purposes of both taxable and tax free activities, and may not be directly linked to either type of activity.

Veszprémi István, tax partner at Deloitte finally concluded: The joint position of the Ministry of Finance and the tax authority, even though casts a light on several significant ambiguous issues, and is thus expected to be particularly useful for market players, unfortunately fails to elaborate on the tax implications of the termination or transfer of lease contracts. Mr. Veszprémi emphasised: In this question a new position is expected to be issued in response to the joint initiative of the Lease Association and Deloitte.

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