GST ON FINANCE LEASES - This week the IRD have released their draft interpretation statement (IS) – ‘GST and finance leases’.

The draft IS separates finance leases into three categories with different GST treatments. These are:

  • Hire purchase agreements
  • Agreements to hire
  • A third residual category

A finance lease is a commercial term that describes a lease of an asset for a fixed term and the payments made under the lease are determined by the assets value and not the value of the use.

Hire purchase agreements

One situation where a finance lease will be a hire purchase agreement is where:

  • The agreement is made at retail; and
  • There is an option for the lessee to purchase the asset at the end of the term of the lease.

The commissioner considers ‘at retail’ to mean that the lessee will be the end user of the goods rather than on sell or on-lease long term. The commissioner also considers that business to business finance leases can be made at retail for the purposes of determining whether a lease is a hire purchase agreement.

An option to purchase exists if the lessee has the right to buy the goods and the lessor is obliged to sell the goods to the lessee if they exercise their right to buy.

Note that a residual value clause that guarantees a certain value of the asset to the lessor does not in itself count as an option to purchase. It will however be an option to purchase if it provides a mechanism for the lessee to retain possession of the asset and allow for ownership to be transferred to the lessee.

One other issue the draft IS considered was ‘side arrangements’ where finance leases and options to purchase were entered in to in different agreements. The commissioner considers that we need to look at the true nature of the agreement. If the agreements are entered into at the same time, they should be read together as one agreement.

Hire purchase agreements also include:

  • An agreement for the purchase of goods by instalment payments where the purchase is given possession before the total amount payable has been paid regardless of how the instalment payments are described in the agreement.
  • An agreement to sell goods at retail where the buyer grants security over the goods to the seller for some or all of the purchase price and the property in the goods passes to the buyer subject to the security.
  • A sale and loan arrangement under which a person lends money on the security of goods bought at retail if various conditions are met.

Where the finance lease is a hire purchase agreement, GST should be returned and claimed at the time the agreement was entered into.

Agreements to hire

Agreements to hire includes leases of goods but doesn’t include an agreement:

  • Where property in the goods passes to the lessee; or
  • That expressly contemplates that the property in the goods will pass to the lessee.

Naturally, a finance lease that provides for property to pass to the lessee or expressly contemplates for property to pass will not be an agreement to hire.

The draft IS looks at what ‘expressly contemplates’ means.

The commissioner interprets this narrowly and considers that the exclusion does not apply to a agreement under which title passing is only a possibility at the time of supply. This means that the inclusion of an option to purchase does not exclude the finance lease from being an agreement to hire even if that option is exercised. An agreement with an option to purchase however will be a hire purchase agreement where the agreement is made at retail.

The Commissioner also considered the approach in HMRC v Mercedes-Benz Financial Services UK Ltd inappropriate. This case distinguished between options where the lessee has a genuine decision to make in determining whether to exercise the option and options where the only economically rational choice is to exercise the option (e.g. option to purchase for $1).

Though the UK VAT legislation has similar wording, in this case, “expressly contemplates” needed to be interpreted in light of the EU VAT Directive. The question was ultimately ‘whether ownership would pass in the normal course of events’.

The Commissioner says that if the case were followed, this would introduce further uncertainty in interpreting which option should be regarded as expressly contemplating property will pass.

Where the finance lease is an agreement to hire, it is treated as an ongoing supply and GST is accounted for over the term of the lease at the earlier of:

  • When a tax invoice is issued; or
  • When a payment becomes due

Third Category agreements

The last category the IS refers to is the ‘third category’ which is essentially a residual category. Any finance lease that is not a hire purchase or an agreement to hire will come under this.

A finance lease is likely to be under this category if:

  • The agreement is not at retail; and
  • The agreement expressly contemplates for property to pass to the lessor.

If a finance lease is part of this residual category, then the GST is accounted for at the earlier of when the supplier issues a tax invoice or receives payment for that supply.

Value of supply

A finance lease can also be a credit contract regardless of which of the three categories it falls under.

Interestingly, the definition of ‘credit contract’ refers to a definition in the repealed Credit Contracts Act 1981 (CCA) which was repealed and replaced by the Credit Contracts and Consumer Finance Act 2003 (CCCFA).

Generally, most finance leases will meet the definition of a ‘credit contract’ under the CCA, however, the CCCFA definition is narrower. The CCCFA essentially requires there to be a debt and payment of the debt to be deferred under the agreement.

Depending on the terms of the agreement, a finance lease may not come under this definition as some agreements consider each payment becomes due and payable when required under the lease.

Where a finance lease is a ‘credit contract’ under one Act and not the other, the parties can elect to be under one Act, or the other.

The Commissioner considers that the default position is the definition under the CCA first with the ability to elect to use the CCCFA definition.

Where the finance lease is treated as a credit contract, the cash price (or the upfront price) of the property must be determined for GST purposes. Any amount payable above the cash price will not attract GST as it will be a financial service. Note that the amount payable should include the cost of exercising any option to purchase or guaranteed residual value.

Both parties to the contract must agree on the GST treatment as only one party can prevail. The Commissioner’s view is that this is likely to be the supplier/lessor and that ultimately, the contract and tax invoice(s) need to reflect the agreed position.