Changes to PCP contracts and the impacts of HMRC latest announcement

PCPs are a form of vehicle lease, which are commonly used in vehicle purchases. They allow the customer to pay a series of lease payments and then make a choice whether to pay final payment to acquire the car.

HMRC have recently announced, following a European Court of Justice (ECJ) decision, a change to the way that VAT is to be applied PCPs which could significantly impact the new and used car finance market. The change will impact the customer and the dealer. The ECJ decided that that the existing PCP product was equivalent for VAT purposes to a long-term hire agreement, or Personal Contact Hire (PCH).

Under current rules where PCP is regarded as a supply of goods, VAT is due on the full sales price at the initial handover of the car. In future, however, HMRC’s position is that if the final instalment is approximate to the vehicle’s open market value, then PCP will be regarded as a supply of services. As with PCH, this means that VAT will only be due on the amounts the customer actually pays to the finance company and only at the time of those payments.

Furthermore, interest currently charged on PCP deals will no longer be recognised as anything other than part of the payment for the hire of the car and will therefore attract VAT. This differs from the current position where the interest charge is VAT exempt.

The new arrangements are advantageous in two respects – VAT is deferred until the date of customer payments and is only due to the extent of those payments. For customers who hand back their car at the end of the deal, this results in a significant reduction in the VAT cost.

However, there are two factors which means that the VAT burden to the sector is likely to increase overall. Firstly, interest on PCP deals ceases to qualify for VAT exemption. Secondly, there is one critical aspect overlooked by HMRC in their announcement. Under current rules when PCP cars are returned to a finance company, they are eligible for sale using the margin scheme. However, cars returned after a lease are ‘qualifying cars’ and VAT is due on their full selling price. This change will be significant to the used car market within a couple of years. Dealers and customers alike will need to adapt.

If you would like to discuss this in more detail please email Paul Locker or call us on 01772 821 021.