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UK Customs Changes VAT Policy On Supplies To Business

by Robert Lee,, London

21 November 2003

The UK Customs & Excise Department (HMCE) has announced a change in its policy regarding the VAT (Value Added Tax) treatment of certain services supplied to a business and used for both business and private purposes, and to the period over which non-business/private use should be considered.

Businesses generally apportion the VAT that they have paid on services with the proportion attributable to business use being treated as input tax.

While businesses should, for most services, continue to apportion in this way, Customs now accept that businesses may, in certain limited circumstances, choose to treat all of the VAT on some services as input tax and then account for output tax on the non-business use of the goods to which the services relate.

This option for VAT paid on services may only be used for:

• Certain construction services (see below) where a person became entitled to an input tax credit or repayment before 9 April 2003; and

• other services which are incorporated into goods used in the business and which significantly increase the value of the goods to the business.

HMCE sets out the background as follows:

In 1991 the European Court of Justice (ECJ) ruled in the case of Lennartz v Finanzamt Munchen III that a taxable person who uses a car partly for business and partly for private purposes has a right to a total and immediate input tax deduction in respect of VAT incurred on purchase of the car. Where a person chose to use this approach (subsequently widely described as the "Lennartz mechanism"), they were obliged to account for output tax on the private use under Article 6(2) of the Sixth VAT Directive. Although the specific case involved a car, the mechanism was seen as applicable to supplies of goods in general.

News Release 1/92 set out Customs' view of the implications of Lennartz in respect of goods. It stated that the ruling did not apply to VAT on services; where there was business/non-business use, apportionment was mandatory.

A recent ECJ case, Wolfgang Seeling, involved a German businessman who had constructed a house both as his home and for use in his business. Although the substantive issue was whether the private use was exempt, the decision of the court makes it clear that all the construction costs could be dealt with through the Lennartz mechanism. The court has therefore accepted that VAT on construction services that result in the construction of a building can be dealt with under the mechanism.

In Budget 2003, amendments to Schedule 4, paragraph 5 of the VAT Act provided that, with effect from 9 April 2003, land, buildings and civil engineering works were removed from the Lennartz mechanism. This was done because Customs had become aware that schemes were being put in place to exploit Lennartz for tax avoidance purposes. As a result, no output tax charge arises on the private or non- business use of such land, and there is no entitlement to recover VAT incurred
on either goods or services insofar as the inputs are used for such private or non-business use (i.e. the VAT incurred must be apportioned).

A number of tax advisers have suggested that there is no basis in European law for these changes and say that their conclusion is supported by the Seeling judgment. Customs do not agree. The judgment is that when the Lennartz mechanism (Article 6(2)(a) of the Sixth Directive) is applied to a building, it gives rise to taxable deemed
supplies, not exempt ones. However, there is a derogation in Article 6(2) that allows Member States to withdraw the Lennartz mechanism altogether for certain assets, so there is no output tax on deemed supplies relating to private use, and no right to full deduction of VAT incurred on those assets. Customs consider that the Budget 2003 changes fall squarely within this derogation.

Following the judgment in Seeling, Customs have made the following changes in their policy on the Lennartz mechanism:

  • While there is a potential argument that the Lennartz mechanismhould be seen as a narrow 'private use' mechanism rather than one that is available for wider non-business use, Customs are continuing their policy of not drawing such a distinction.
  • The Lennartz mechanism can apply in respect of purchases of services where those services are incorporated into goods used in the business and significantly increase the value of the goods to the business.
  • The Lennartz mechanism is not available for land, buildings or civil engineering works (or services related to them such as construction services) where no entitlement for any qualifying input tax arose prior to 9 April 2003.
  • The Lennartz mechanism is available for other types of goods; for example computers, motor caravans, yachts and aircraft. Services which improve these goods, e.g. a substantial refurbishment, would also qualify. Customs will normally require the output tax charge under the Lennartz mechanism to be calculated over a maximum five year period based on straight-line depreciation.
  • VAT on services that are consumed in relation to day-to-day activity, such as repair and maintenance, must continue to be apportioned. However, if businesses consider that they should be entitled to use the mechanism for a particular service (such as, say, the major restoration of a business vehicle), they should contact
    Customs National Advice Service on 0845 010 9000 with details.
  • In all cases where the Lennartz mechanism is available for use by a business, the business does not have to use that mechanism and can instead apportion the VAT paid, treating as input tax the proportion attributable to business use.

Customs now accept that the Lennartz mechanism can be applied to certain construction services on buildings or civil engineering works with mixed use. The services concerned are those which resulted in, or will result in, the construction of a new building or civil engineering work, or a major refurbishment or extension of an existing building. At least part of the input tax on those services must have been incurred before 9 April 2003.

The calculation of the Lennartz charge for private use of a building poses particular problems in arriving at a reasonable value for the annual cost of the private or non-business use. In the Seeling case, reference was made to "the duration of the economic life" of immoveable property such as land and buildings. Customs consider that
the 20 year period referred to in this context is also a fair time frame over which the private/non-business use of immoveable property should be measured. Therefore, Customs have decided that, when applying the Lennartz mechanism to immoveable property, the output tax charge should be calculated over a maximum 20-year period based on straight line depreciation, unless a shorter period is indicated (e.g., where a taxpayer's leasehold interest in the building has under 20 years to run).


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