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Hire Purchase & Personal Contract Plans: VAT Treatment & Defaults | Indirect Tax Matters May 2020

VAT Treatment of HP & PCP Agreements

The supply of a car under either a hire purchase (HP) agreement or Personal Contract Plan (PCP) is a supply of goods for VAT purposes. As soon as the customer commits, there is a supply by the car dealership to a finance house (typically a lending institution or a finance company within the manufacturer’s corporate group) and a subsequent supply from the finance house to the customer. These two supplies occur simultaneously. Under both forms of financing, VAT on the full value of the car is paid upfront by the finance house to Revenue when the customer takes possession of the car.

Under HP, ownership of the car automatically passes from the finance house to the customer following payment of the last instalment (usually the 36th). The monthly instalment consists of two amounts: a capital payment to represent the value of the car plus credit financing. The former is a non-event for VAT (as the VAT has already been accounted for upfront) whereas the latter is exempt from VAT (interest). Finance houses that supply cars on HP are entitled to full deductibility in respect of their purchase of the cars. How the exempt credit finance impacts on the finance house’s ability to deduct the VAT incurred on overhead costs in relation to its HP business has been addressed by the Court of Justice of the European Union with the precise methodology to apportion the VAT on such costs now a matter for agreement with Revenue.

PCPs are a type of hire-purchase agreement, typically for car contracts, which for the customer involves three separate phases. Phase I - the deposit, which typically can be between 10% and 30% of the value of the car. Phase II - the regular monthly repayments spread over the term of the contract, usually between three to five years. Unlike HP agreements, payment of the final sum due under the contract does not see ownership pass to the customer. Payment of the final sum leads to Phase III – a choice of one of three end-of-term Options:

(i) return the car to the dealer and pay nothing further; 

(ii) pay the final instalment of the “guaranteed minimum future value” (GMFV) to own the car outright, or 

(iii) trade-in the car and enter into a PCP on a new car.

Figures from industry suggest that less than 2% exercise Option (i) but even then, Option (i) might not be as straightforward as it seems. At the outset, the customer will have agreed monthly instalments based on an agreed maximum number of kilometres over the term of the PCP, or perhaps adhering to a servicing schedule. There may also be general wear and tear to the car which would need to be remedied before the car is sold on by the finance house.

To the extent that such remedial costs are charged to the departing customer, the finance house needs to understand if such a charge is treated as additional payment under the PCP contract, a VATable supply taxed at 23%, maybe a supply of repairs and maintenance taxed at 13.5%, or perhaps entirely outside the scope of VAT as a penalty or compensation. 

Option (ii) sees a final balancing payment (a ‘balloon’ payment) known as the Guaranteed Minimum Future Value (GMFV); the final instalment payable at the end of the contract if the customer is to own the car. This figure is based on the finance house’s estimate of the future value of the car at contract end, based on a range of variables such as the make and model of car, the length of agreement, the anticipated annual mileage, etc. It is the anticipated value of the GMFV which keeps the monthly instalment payments low (when compared to the HP monthly amounts) but which presents the customer with a large buy-out value at contract-end if he/she is to acquire the car.

Having accounted for the VAT upfront on the value of the car, payment of the GMFV does not attract a further charge to VAT.

While exercising Option (ii) will see title in the car pass to the customer, exercising Option (iii), and largely unbeknown to the average customer, title will pass fleetingly to the customer before going elsewhere, typically back to the original car dealership. The car under the existing PCP contract is then treated as “traded-in” against a new PCP-financed car but if the market value of the car has dropped below the GMFV, perhaps due to wear and tear, or unanticipated factors such as diesel cars being phased out, the customer may need to pay a larger deposit to enter in to the new agreement. 

While the customer is presented with three Options at the end of the PCP term, one of which is simply to walk away, VAT law requires certainty from the outset: is the contract that of leasing services, where title does not pass to the customer and so VAT is due on the full amount of each monthly instalment, or goods, where VAT is due upfront and the monthly instalments include an element of exempt credit financing. At the direction of the CJEUii, we now know that the test is simply whether “ can be inferred from the financial terms of the contract that exercising the option [to take title] appears to be the only economically rational choice that the lessee will be able to make at the appropriate time if the contract is performed for its full term”

In Revenue’s opinion, which echoes the view within industry, where Options (ii) or (iii) are most likely to be chosen by the customer (bearing in mind a less than 2% preference for Option (i) but also weighing up the GMFV when compared to the predicted market value) the PCP contract is likely to be treated as a supply of goodsiii.

Finance houses that supply cars on PCP are entitled to full deductibility in respect of their car purchases. Where the assessment of the PCP terms is that the contract constitutes a supply of goods, the exempt credit finance will impact on the finance house’s ability to deduct the VAT incurred on overhead costs. As with HP agreements, the methodology to apportion the VAT on such costs will be a matter for agreement with Revenueiv.

Defaults & Repossession

Based on Central Bank data, as at August 2019 total car finance as a share of consumer credit stood at 44%, up significantly from the 8% recorded June 2012. Hire purchase financing consisted of the largest amount of personal financing by value at approximately €3.1bn, of which €1.2bn of that figure was for PCP financing. With other car financing standing at €.09bn, PCP represented 30% of all car financing.

The PCP market now accounts for €2.7bn of Ireland's nearly €3.8bn in outstanding car debt. As of June 2019, 65,500 PCP contracts were in place with PCP credit estimated to be around €1.2bnv

As a result of the COVID-19 crisis, the world’s motor industry is facing an unprecedented challenge. In an attempt to manage reduced household budgets, many people are struggling with their monthly car payments under their HP agreements or PCPs.

While lending institutions and car finance providers (“finance houses”) have responded by offering customers on PCPs payment holidays of up to three months, with the arrears recouped by spreading over the remainder of PCP term, extending the term by an additional three months, or by increasing the final balloon payment, and with some institutions also extending such reliefs to HP agreements, the volume of customers falling into arrears beyond the three month holiday period as they struggle meet the monthly payment terms is likely to grow.

Regrettably, this has the potential to increase the number of customer defaults and car repossessions as customers hand back cars where they can no longer adhere to the monthly repayment schedule.

Having accounted for the VAT due on the full value of the car upfront, finance houses must now consider the VAT position where there is a shortfall in customer payments under HP or PCP contracts leading to car repossessions.

Hire Purchase

The Irish Revenue guidance on VAT and hire purchase agreementsvi  notes that finance houses are entitled to bad debt relief on a pro-rata basis in respect of hire purchase transactions when a default occurs in respect of the VAT element of the outstanding payments. Where a hire purchase agreement is terminated early and the car taken back in to the finance house’s possession, bad debt relief can be claimed in respect of the VAT element of the outstanding payments (subject to the application of formulae to strip-out the value of the interest from the amounts paid to date as well as from the amounts outstanding to determine the value of the bad debt VAT).

If the finance house repossesses goods before the hire purchase agreement has run its course, as the result of early termination or customer default, title would not have been transferred from the finance house to the customer and so a subsequent sale would be a taxable supply on which the finance house must account for VAT. 

Personal Contract Plans

Although PCP arrangements are slightly more complicated than HP agreements, the guidance provided by Revenue on PCPs is not as extensive as that for HPs. Before the COVID crisis, feedback from the motor industry noted that less than 2% of PCP customers exercised the Option (i) hand-back, and so this may suggest that the question of bad debt relief has yet to come up in any volume that would require Revenue, at the urging of industry, to consult on such issues and update their PCP advice accordingly. 

Notwithstanding that the Revenue’s PCP guidance is silent on the availability of bad debt relief, it does confirm that “Revenue is prepared to accept that a PCP may be treated as a supply of goods, in the same manner as a standard hire purchase arrangement, where at the outset of the agreement the only economically rational choice for the customer is to purchase the vehicle at the end of the contractvii. Therefore, on a like-for-like basis the full range of consequences and reliefs applicable to goods supplied under HP agreements must equally apply to goods supplied under PCP contracts.

Guidance does not address the position of customers not paying the GMFV but in circumstances where VAT has already been accounted for on the full value of the car upfront, or where there is an early termination of the PCP arrangement, or the treatment of onward sales. 

The specific rules governing the operation of bad debt relief under HP agreements pre-suppose that there is a debt due under the agreement. The bad debt procedure for HP agreements considers the total amount paid by the customer against the (broadly) 36 instalments scheduled for payment under the HP agreement. With PCP contracts there is also scope to default on the instalment payments but full payment of those instalments might still only see 60% of the car value paid to the finance house. The outstanding amount is the GMFV but as this is not an amount scheduled for payment and is entirely discretional (pending an Option (ii) election), does its non-payment by the customer constitute a bad debt at the end of the financing period?

On the basis that title would not have transferred from the finance house to customer under default a subsequent sale should be a taxable supply on which the finance house must account for VAT. But whether or not the sale is VATable, if bad debt relief does not apply in the absence of payment of the GMFV, what then is the position if the onward selling price of the (now) used car is less than the GMFV? The finance house would already have accounted for VAT on the full value of the car at the commencement of the PCP term but if it receives less than 100% of that value from the customer instalments and subsequent sale there would be a clear deficit between the amount against which VAT had been accounted for by the finance house and the total value of the payments received. How should the VAT on that deficit be addressed?


As the COVID pandemic continues to run its course and with warnings of a major global recession to come, an industry which was already struggling may now be faced with a glut of repossessed cars which cannot be sold on. 

However, on the VAT front there are strong arguments that bad debt relief should be given not only for defaults under PCP but also where the market value is less than the GMFV as PCP contracts, treated as supply of goods for VAT purposes, should also share the VAT reliefs afforded to HP agreements.

This article provides only a high level overview of some of the implications of default and repossessions of cars under HP or PCP agreements. We are happy to discuss how this impacts your business specifically.

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