Italian design and influences
always appear to have an impact on our motor industry. Last year, Italian manufacturers
greatly influenced the car markets, Alfa Romeo and Maserati made a come back, even Ferrari
nearly managed to sneak victory in the Formula One constructors’ cup. Unusually,
though, even the Italian Government has gotten into the act!
Whilst some motor dealerships may already
have taken advantage of a VAT case brought against the Italian Government, many more will
need to give it serious thought as new legislation is anticipated in the UK to reflect the
findings of the Italian case.
Focus on exempt income
Following criticism by the European Commission over the treatment of VAT, the Italian
Government has now become the precedent used by UK motor dealerships to reduce their VAT
bills. The Italian Government was taken to task because their VAT legislation required
Italian businesses to treat the sale of a car as outside the scope of VAT where they were
not entitled to any deduction of VAT on its initial purchase. Under the European
legislation, which governs VAT, such sales should have been exempt from VAT. This whole
matter (known as the “Italian case”) has had a number of spin offs.
In particular, it has focussed
Customs’ attention on other sources of exempt income traditionally earned by
dealerships including finance and insurance related commissions. In the past, Customs
appear to have taken the view that exempt income earned from commissions was incidental to
a dealer’s main trading activities. The advent of exempt income arising from the sale
of cars under the findings of the Italian case appears to be testing this view.
The downside is that Customs are likely to
expect a restriction on VAT recovery on costs both directly and indirectly related to
these exempt lines of income.
The Italian case
UK car dealerships have been able to use the Italian case to obtain a VAT benefit on the
sale of cars that have been used for demonstration purposes. VAT incurred on demonstration
cars is not normally recoverable from HM Customs & Excise, because they are used
partly for private purposes. Where the dealership has subsequently managed to sell
demonstration cars at a profit, Customs have required VAT to be charged on the profit
element. The Italian case has now shown this treatment to be incorrect. Such sales are
exempt from VAT in their entirety. Dealerships have, therefore been able to reclaim VAT
previously paid to Customs on such sales made in the last three years, and will benefit on
future sales by not having to charge VAT.
Partial exemption impact
The potential sting in the tail for any dealership making a claim under the provisions of
the Italian case arises as a result of complex VAT provisions relating to partial
exemption. Put simply, these provisions prevent the recovery of VAT on purchases and
expenses that can be attributed to a sale that is exempt from VAT. For example, if a
dealership installs a new radio in the demonstration vehicle in order to sell it, because
the VAT on the radio can be attributed to the sale, which is exempt from VAT, that VAT
cannot be recovered.
In addition to the direct costs
attributable to the sale, the partial exemption provisions also prevent the recovery of a
proportion of the VAT incurred on the dealership’s general overheads, e.g. VAT on
telephones, computers, heat, lighting, etc. The cumulative effect of the irrecoverable VAT
on direct costs and overheads might be sufficient to negate any benefits from not charging
At present, dealerships can choose whether
or not to apply the Italian case. For some dealerships, a sizeable VAT recovery will be
achieved. For others, it will not be worthwhile because of the VAT recovery problems that
they will suffer.
At some time in the near future, Customs will be required to introduce new legislation to
ensure the principles of the Italian case are followed. From that point, the
implementation of the principles established in the Italian case will be mandatory. All
dealerships selling demonstrator vehicles will then need to consider the partial exemption
provisions and how they impact on demonstrator sales. At the same time, income earned from
exempt finance and insurance commissions will need to be taken into consideration.
Again, some dealerships will find
themselves in a beneficial position. Others will find that the partial exemption
provisions either remove any VAT benefit or make the VAT accounting so complex that any
benefit is outweighed by the additional administration required.
Given the certain introduction of
legislation in this area and the need to take account of other sources of exempt income,
dealerships should now be considering what they could do to ensure that they do not suffer
any adverse effects.