Firstly, it is important to identify the type of credit agreement that is in place. In your client’s circumstances, under an HP agreement, where it is anticipated that title will pass in the future, this is treated as a supply of goods at the outset, thus meaning VAT is charged and recoverable at the start of the agreement.
However, lease agreements where title will not pass, or agreements where there is a large balloon payment at the end that make it highly unlikely that title will pass, are classed as services, and VAT is charged on the monthly payments, not at the outset. It is often worthwhile checking how the supplier/finance company is treating the supply.
As your client has taken possession of the goods, the supply cannot be ‘undone’, even though the payment terms haven’t been fulfilled. Equally, the return of the goods is not a supply by your client to the finance company as it has the right to repossess the goods which your client does not yet legally own. No output tax is due by the client.
Instead, Regulation 38 (VAT Regulations 1995) is applicable as it can be treated as a reduction in the consideration for a supply, as confirmed in the case of General Motors Acceptance Corporation UK Ltd (GMAC) case (LON/01/242), and HMRC’s now archived VAT Information Sheet 05/04. The HP company may issue you with a VAT credit note, or other document having the same effect, for the reduction in consideration, which you will need to use to amend the input tax originally claimed on your VAT return in which the credit note or other document is issued.
Alternatively, where both parties are VAT registered and agree, no adjustments are required to the either party’s VAT return – any credit note issued should clearly state that ‘this is not a VAT credit note’.
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If you have a VAT query why not contact the VAT Advice Line on 0844 892 2470 to discuss the implications. Our team of experts have a wealth of experience and can also provide a written consultancy service at competitive rates.