Volkswagen Financial Services has won a landmark case against Her Majesty’s Revenue and Customs (HMRC) concerning VAT rebates which could affect motor finance providers in the UK.

The Court of Appeal (COA) upheld a challenge bought by Volkswagen Financial Services (WWFS) concerning the recovery of some of its VAT.

From a tax perspective, VWFS makes two supplies to the customer: a taxable supply of a vehicle, on which VWFS must account for output tax, and an exempt supply of finance.

VWFS is entitled to recover the VAT paid on its overhead expenditure, such as expenditure on hotel accommodation, staff meals and drinks, heating, lighting and so on to the extent that it is used for the purposes of its taxable business activity (sale of cars) but not to the extent it is used for its exempt business (financing those cars).

HMRC uses a system known as a partial exemption special method (PESM) to figure out the difference between the two costs.

VWFS had proposed to HMRC a PESM for calculating its recoverable input tax, which saw each HP contract as one taxable transaction and one exempt transaction, and HMRC’s tax would be split equally between the two. VWFS argued it should be entitled to reclaim VAT on a 50/50 basis.

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HMRC, on the other hand, argued that the correct tax treatment of the residual input tax on overheads was that they were all attributable to financing the cars, and not expenses, and therefore no tax was recoverable by the car finance company.

The court found VWFS’ approach the correct one.

The case has been in the courts since 2011, meaning the decision in VWFS’ favour has taken five years but is a ruling that could open the door for other motor finance companies to renegotiate their arrangements with HMRC and reclaim past VAT.

Speaking to Motor Finance, KPMG legal services partner Amanda Brown said the decision (unless it is successfully appealed by HMRC) would enable providers of HP finance to ensure a fair recovery of overhead input VAT and potentially make claims for the past, the value to the industry as a whole running to millions of pounds.

Brown pointed out that the COA was faced with a stark choice of 50% or 0% recovery in this case because of the alternatives presented to the FTT. The COA determined that 0% deprived VWFS of recovery to which it must be entitled. While future PESMs may not be as generous as 50-50, they will certainly be above the 0% proposed by HMRC, which Brown said several finance companies had been using.

A spokesperson from HMRC told Motor Finance that HMRC was carefully considering the judgement.