Neutral Citation Number: 2015 EWCA Civ 1211 [617885]

Neutral Citation Number: [2015] EWCA Civ 1211

Case No: A3/2014/2814
IN THE COURT OF APPEAL ( CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL (TAX AND CHANCERY
CHAMBER)
NUGEE J – [2014] UKUT 200 (TCC)
ON APPEAL FROM THE FIRST -TIER TRIBUNAL ( TAX CHAMBER )
JUDGE MICHAEL TILDESLEY OBE & RUTH WATTS DAVIES FCIPD
MIH – [2013] UKFTT 381 (TC)
Royal Courts of Justice
Strand, London, WC2A 2LL

Date: 26 November 2015
Before :

THE CHANCE LLOR OF THE HIGH COURT
LORD JUSTICE PATTEN
and
LORD JUSTICE CHRISTOPHER CLARKE
– – – – – – – – – – – – – – – – – – – – –
Between :

THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMS Appellant
– and –
MERCEDES -BENZ FINANCIAL SERVICES UK
LIMITED Respondent

– – – – – – – – – – – – – – – – – – – – –
– – – – – – – – – – – – – – – – – – – – –

Mr Owain Thomas and Mr Matthew Donmall (instructed by the General Counsel and
Solicitor to HM Revenue and Customs ) for the Appellant
Mr Kevin Prosser QC (instructed by Mishcon de Reya LLP ) for the Respondent

Hearing date : 21 October 20 15
– – – – – – – – – – – – – – – – – – – – –
Approved Judgment

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

Lord Justice Patten :
Introduction
1. This is the judgment of the Court.
2. This is an appeal by the Commissioners for Her Majesty’s Revenue and Customs
(“HMRC”) against a decision of the Upper T ribunal (Tax and Chancery Chamber)
(Nugee J) released on 2 May 2014. It concerns the proper tax treatment of so -called
Agility hire purchase contracts entered into between Mercedes -Benz Financial
Services UK Limited (“MBFS”) and its customers in respect o f the supply of
Mercedes -Benz vehicles. The particular issue on which the appeal turns is whether
for VAT purposes the Agility contract falls to be treated as a supply of services
(which is MBFS’s case) or, as HMRC contend, a supply of goods. The resolut ion of
this issue turns on the correct interpretation and application of Article 14 of the
Principal VAT Directive (2006/112/EEC) ( “the Directive”) which, so far as material,
provides:
“1. 'Supply of goods' shall mean the transfer of the right to
dispose o f tangible property as owner.
2. In addition to the transaction referred to in paragraph 1, each
of the following shall be regarded as a supply of goods:
(a) the transfer, by order made by or in the name of a public
authority or in pursuance of the law, o f the ownership of
property against payment of compensation;
(b) the actual handing over of goods pursuant to a contract
for the hire of goods for a certain period, or for the sale of
goods on deferred terms, which provides that in the
normal course of events ownership is to pass at the latest
upon payment of the final instalment;
(c) the transfer of goods pursuant to a contract under which
commission is payable on purchase or sale.”
3. The facts are set out in paragraphs 4 -16 of the Upper Tribunal Decision which, for
convenience, I have reproduced as an Appendix to this judgment. But the following
points are of particular relevance:
(1) the Agility contract is one of three financial products provided by MBFS to its
customers in relation to Mercedes -Benz vehicle s. The other two are “Hire
Purchase” and “ Leasing ” contracts . Under a Leasing contract, the customer
simply hires the vehicle for 36 months in return for a monthly rental payment.
There is no option to purchase at the end of the term. Under the Hire Pu rchase
(“HP”) contract, the customer is given the option to purchase the vehicle at the
end of the hire period usually on payment of a small option fee of £95. Some
HP agreements provide for the balance of the price (after p ayment of a
deposit) and the am ount of the credit to be paid in 36 equal monthly
instalments over the term of the agreement so that only the option fee remains

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

payable by the customer who wishes to acquire the vehicle. But others
provide for lower monthly payments and for a substantial “balloon” payment
as the final monthly instalment together with the option fee. In both cases, the
customer will have paid the price of the vehicle and the amount of credit by
the end of the term so that a failure by him to exercise the option to purchas e
would be wholly uncommercial;
(2) the Agility agreement, like the HP agreement, provides for a term of 36
months with an option to purchase at the end of the term. Like the Leasing
and the HP agreements, in most (if not all) cases, it is also regulated unde r the
Consumer Credit Act 1974. But it differs from the HP agreement in that the
monthly payments are calculated by reference to the difference between the
purchase price of the vehicle and its anticipated residual value at the end of the
term plus intere st so that , even when the customer has made all the obligatory
contractual payments, a substantial amount of the original purchase price will
remain unpaid. If the customer decides at the end of the term that he does
wish to exercise the option to purchas e, his final monthly payment will
therefore be a sum equal to the vehicle’s estimated residual value in addition
to the £95 option fee. The final monthly payment (described as an Optional
Purchase Payment) amounted in the examples given to something in ex cess of
40% of the original purchase price;
(3) if the customer decides not to exercise the option to purchase , the vehicle is
disposed of by MBFS to a sister company under a guaranteed buy -back
agree ment which means that it takes no risk “on the metal”;
(4) where (as in most cases) the HP and Agility agreements are regulated
agreements then the customer is given a statutory right of termination under
the Consumer Credit Act. If exercised, the most that MBFS can recover from
the customer is half the total amou nt that is payable under the ag reement.
4. It is common ground that the Leasing agreement constitutes a supply of services for
VAT purposes. There is no provision in the contract for the custo mer to acquire the
property in the vehicle. But the parties are divi ded as to whether the Agility
agreement with its substantial optional payment for the acquisition of the vehicle falls
to be treated in the same way.
5. The first submission of HMRC is that, properly construed, Article 14(2)(b) identifies
as a supply of goods any contract of hire under which title will normally pass no later
than upon payment of the final instalment. In other words, that the reference in
Article 14(2)(b) to the contract providing that “in the normal course of events
ownership is to pass at th e latest …” is concerned to specify when title is to pass
rather than whether or not it will pass . If this construction is correct then there is no
need to venture into issues of whether, economically or otherwise, the purpose of the
contract was to secur e the passing of title or the significance for VAT purposes of the
optionality of the right to purchase the vehicle. Article 14(2)(b) would catch every
hire contract under which the customer is able to acquire title to the goods by no later
than the payme nt of the final instalment.

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

6. Mr Thomas for HMRC argued before the First -tier Tribunal that this construction of
Article 14(2)(b) derived support from the French language version of the text of the
Directive which does not refer as such to the normal cours e of events but states:
“la remise matérielle d'un bien en vertu d'un contrat qui prévoit
la location d'un bien pendant une certaine période ou la vente à
tempérament d'un bien, assorties de la clause que la propriété
est normalement acquise au plus tard l ors du paiement de la
dernière échéance ”
7. The First-tier Tribunal followed what seems to have become its normal practice of
declining to enter into a consideration of any foreign language version of the
Directive without the benefit of expert assistance: s ee e.g. Volkswagen Financial
Services (UK) Ltd v Revenue and Customs Commissioners [2012] SFTD 190 at [60].
The First -tier Tribunal rejected this argument and it was not pursued on appeal to the
Upper Tribunal. We have therefore heard no substantive argu ment on the point,
although HMRC have reserved their right to take the point on any reference of this
case to the CJEU.
8. The argument before the Upper Tribunal therefore concentrated on whether the First-
tier Tribunal was right to hold that a contract of hire falls within Article 14(2)(b) if,
under its terms, the passing of title in the goods is a normal rather than an abnormal
event. The First -tier Tribunal had set out it reasons in [91] -[96] of its Decision:
([2013] UKFTT 381 (TC) ):
“91. The Tribunal pr efers HMRC’s alternative construction of
in normal course of events namely that the possible passing of
title was an essential feature of Agility rather than an
eventuality which may only arise in limited and exceptional
circumstances. HMRC’s alternative c onstruction did not stray
away from the governing principle that the application of
Article 14(2)(b) was determined by the terms of contract. The
Tribunal’s analysis of Agility’s terms found that the option to
purchase constituted the sole realistic option under the
agreement. The transfer of ownership was, therefore, central to
the Agility contract, not tangential.
92. The phrase normal course of events is directed at the legal
realities of a contract for sale with an option to purchase. The
phrase recogni ses that under the terms of such a contract
ownership might not pass but that possibility did not prevent
the contract from being a contract for sale under which
ownership normally transferred. Thus the fact that ownership
might not transfer under the Agil ity contract did not preclude it
from being a contract for sale. The passing of title was central
to Agility which meant that ownership would normally pass
under its terms.
93. This Tribunal has arrived at the same conclusion as
expressed in Rodney Hogarth :

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

“What usually happens under a hire purchase
transaction is that the customer makes the
payments and eventually becomes the owner of
the goods, in both cases in accordance with the
hire purchase agreement. In my judgment that
course of events is one which is referred to in
Article 5.4 as ‘the normal course of events’, and
such an agreement is an example of an agreement
which ‘expressly contemplates’ that the property
‘will’ pass as mentioned in paragraph 1(2)(b). In
my judgment the fact that the agreement also
contemplates other possible events in which the
property will not pass, such as the premature
termination of the agreement, does not prevent the
agreement from being an agreement which
contemplates that the ‘will inevitably’, but ‘will in
certain even ts’”.
94. Although Hogarth was concerned with the wording of
paragraph 1(2)(b) of Schedule 4 VAT 1994, there was no
argument put forward in this Appeal to suggest that the terms
of Article 5 14(2)(b) were more restrictive than those of the
VAT Act 1994.
95. The Tribunal considers the ratio in Hogarth and HMRC’s
construction of normal, rather than abnormal were
fundamentally different from the Appellant’s more likely than
not test. The former were looking to what the contracts
provided as to when ownership i s to pass. Whereas, the
Appellant’s more likely than not test was about the likelihood
of the subsequent exercise of the option to purchase. The
likelihood appeared to be determined by some form of risk
evaluation based upon a range of extraneous factors n ot directly
related to the terms of contract. In this respect the Tribunal’s
rejection of a role for risk evaluation in deciding the application
of Article 14(2)(b) meant that there was no place for the
Accounting Standards in this Appeal which was not con cerned
with the distinctions between operating and finance leases.
96. The Tribunal also considers that HMRC put forward two
other powerful arguments for why the Appellant’s position was
wrong. First the classification of a transaction as a supply of
goods or services was not one that could only be known at the
end of the term of the contract. If the supply under the Agility
contracts was a supply of goods then VAT must be accounted
for on the sale price of the car at the time when it was handed
over the cu stomer. Under the Appellant’s construction the
correct characterisation of the supply under Agility would only
be known at contract maturity when a decision was required on
the option to purchase. Thus the Appellant’s construction

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

resulted in a situation w here the application of Article 14 did
not produce an answer one way or the other at the time the
vehicle was supplied. Such a proposition was clearly wrong and
offended the principle of legal certainty. Second if the
Appellant’s interpretation was correct , it would exclude all hire
purchase agreements, given the possibility of termination either
in the exercise of a right or because of a default.
9. It was common ground before the Upper Tribunal that there is no decision of the
Court of Justice directly on th e point at issue on this appeal. But the parties were also
agreed about a number of general principles which bear on the proper legal approach
to the interpretation and application of Article 14(2)(b):
(1) the question whether a contract falls within Article 14(2)(b) falls to be
determined at the date of the contract by reference to its provisions and not
with the benefit of hindsight as to whether the customer subsequently chooses
(or not) to exercise the option to purchase;
(2) the concept of supply of g oods has to be determined as a matter of EC law
rather than in accordance with any particular national law so as to be applied
universally across the various legal systems of the EC;
(3) it is objective in nature being applied w ithout regard to the purpose s or results
of the transaction in question and, in particular, without regard to the
subjective intentions of the taxable person: see Newey v HMRC Case C -653/11
at [41]; Dixons Retail plc v HMRC Case C -494/12 at [21].
10. The Upper Tribunal also derived from the authorities the following principles: see
[25](4) -(6):
“(4) Consideration of the economic and commercial realities
is a “fundamental criterion” for the application of the
common system of VAT. Since the contractual position
normally reflects the econo mic and commercial reality
of a transaction, the relevant contractual terms
constitute a factor to be taken into consideration; but
sometimes contractual terms do not wholly reflect the
economic and commercial reality of a transaction, in
particular if it becomes apparent that the contractual
terms constitute a purely artificial arrangement which
does not correspond with the economic and commercial
reality of the transaction: Newey at [42] -[45]. This
passage has very recently been referred to and relied on
by the Supreme Court in Secret Hotels2 Ltd v Revenue
and Customs Commissioners [2014] UKSC 16 at [29]
per Lord Neuberger.
(5) In a passage cited by Jonathan Parker LJ in Tesco plc v
Customs and Excise Commissioners [2003] EWCA Civ
1367 (“Tesco” ) at [41], the Advocate General (Tizzano)
said this in his opinion in Customs and Excise

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

Commissioners v Mirror Group plc Case C -409/98 and
Customs and Excise Commissioners v Cantor
Fitzgerald International Case C -108/99:
“27. In order to identify the key features
of a contract, however, we must go beyond
an abstract or purely formal analysis. It is
necessary to find the contract's economic
purpose, that is to say, the precise way in
which performance satisfies the interests
of the parties. In other words, we must
identify the element which the legal
traditions of various European countries
term the cause of the contract and
understand as the economic purpose,
calculated to realise the parties' respective
interests, lying at the heart of the contract.
In the case of a lease, as noted above, this
consists in the transfer by one party to
another of an exclusive right to enjoy
immovable property for an agreed period.
28. It goes without saying that this purpose
is the same for all the parties to the
contract and thus deter mines its content.
On the other hand, it has no connection
with the subjective reasons which have led
each of the parties to enter into the
contract, and which obviously are not
evident from its terms. I have drawn
attention to this point because, in my vi ew,
failure to distinguish between the cause of
a contract and the motivation of the parties
has been the source of misunderstandings,
even in the cases under consideration here,
and has complicated the task of
categorising the contracts at issue. ”
Jonat han Parker LJ later in his judgment made the point
that the “economic purpose” here referred to by the
Advocate General is not the same as “economic effect”:
two transactions may have the same economic effect but
that does not necessarily mean that they ar e to be treated
in the same way for VAT purposes: see Tesco at [159].
(6) In MBNA Europe Bank Ltd v HMRC [2006] EWHC
2326 (Ch) ( “MBNA” ), Briggs J referred to the same
passage from Advocate General Tizzano’s opinion in
saying (at [35]) that the Court is not hidebound by the
labels which the parties have chosen to apply to their
transactions but must where necessary ascertain the

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

“essential character of the transaction in issue ”. He
continued (at [36]):
“The identification of the “cause” of a
contractual tra nsaction, where necessary to
establish whether it constitutes a supply,
and if so to categorise it as taxable, exempt
or specified, may legitimately entail its
interpretation by reference to the relevant
matrix of background facts known to the
parties of t he type classically explained by
Lord Hoffmann in West Bromwich [2005]
UKHL 44 .””
11. Any analysis of the meaning and effect of Article 14(2)(b) must begin with the words
used. Mr Thomas emphasised before the Upper Tribunal, as he did before us, that the
focus of the words in dispute is on what the contract “provides” and not with a more
general question of what, viewed at the date of the contract, is likely or expected to
happen. Since it is unrealistic to envisage a hire contract which provides in terms that
ownership will pass “in the normal course of events” by a certain date , that phrase has
to be i nterpreted as descriptive of the effect of the relevant terms of the contract. One
approach to this is the timing a rgument I have mentioned which was raised in the
First-tier Tribunal but not pursued on appeal. But HMRC’s alternative approach is to
treat Article 14(2)(b ) as concentrating on the existence as a term of the contract of the
right to purchase the goods rather than the likelihood of the option being exercised.
12. Mr T homas makes the obvious point that the inclusion of both hire contracts and
contracts of purchase on deferred terms within Article 14(2)(b) indicates that the
Directive cannot be re ad as limiting the application of Article 14(2) to contracts under
which the customer was bound to purchase the goods. An HP contract containing an
option to purchase is the obvious type of hire contract to qualify. But Mr Thomas
resists reading into Article 14(2)(b) the need (even on an objective basis) to make any
further inquiry as to the inherent likelihood of the option being exercised. The
contrac t, he submits, falls into the Directive’s extended definition of a supply of
goods if the acquisition of title is the normal method of performing the contract which
is to be inferred from the existence of the option (absent any contractual provisions to
the contrary) rather than some kind of objective determination of the economic
probabilities involved. The judge in the Upper Tribunal thought that the reference in
Article 14(2)(b) to the contract providing that “in the normal course of events
ownership is to pass ” was inconsistent with the argument that it was intended to catch
most types of option: see [32] of the judgment of the Upper Tribunal. But
Mr Thomas’s response to this would be that it proves too much and that the words “is
to pass” have to be read as a pie ce with the preceding words “in the normal course of
events”. The whole phrase is descriptive of a hire contract which, absent special
circumstances, permits ownership to be acquired. That construction does not require
one to look further tha n the terms of the contract itself in order to identify whether
such a contractual mechanism exists.
13. The Upper Tribunal took the view that Article 14(2)(b) calls for an economic analys is
of the transaction :

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

“In my judgment the discernible policy purpose behind the
inclusion of certain contracts of hire in Art 14(2)(b) is to tax
transactions where the customer has in reality agreed to buy the
goods as if they were contracts of sale, even though in law the
customer is not contractually obliged to complete t he purchase.
This explains why the language of Art 14(2)(b) refers to the
ownership of goods passing in the normal course of events, or
normally – it is not concerned with every contract under which
there is a possibility of the ownership passing, but onl y with
those contracts where this can be described as the normal
outcome .”
14. This is obviously a possible interpretation of the descriptive phrase “in the normal
course of events” but it poses difficulties in defining how it is to be accommodated
within the established principles of construction which require the determination of
whether the supply is one of goods or services to be made at the date of the contract
and to exclude any consideration of the customer’s subjective intent in opting for that
method o f financing his acquisition of the vehicle. As Nugee J himself recognised ,
the test of economic reality, if it is to be workable, needs to be able to identify which
types of hire contract with a n option to purchase constitute a supply of goods simply
on an objective assessment of the contract at the date when it is made and without
reference to any available evidence as to the percentage of Agility customers who do
in fact choose to exercise the option to purchase. This means that the focus has to be
on the provisions of the contract itself in order to determine whether ownership will
pass “in the normal course of events” and it brings one back to the difficulty identified
by Mr Thomas in his submissions that the contract itself does not specify whether th e
option is or is not likely to be exercised.
15. The Upper Tribunal’s answer to this con undrum was to resort to the test of economic
purpose explained by Advocate General Tizzano in his opinion in the Mirror Group
case quoted earlier:
“48. What I have found most helpful is the guidance given by
Advocate General Tizzano cited and followed in Tesco .
This requires one to find the contract’s “ economic
purpose”, that is to say, “the precise way in which
performance satisfies the interests of the parties”; or the
element (termed in some legal systems the cause of the
contract) which is the “economic purpose, calculated to
realise the parties' respective interests, lying at the heart
of the contract.” It seems to me to follow that the
question under Art 14(2)(b) i s whether the contract is one
whose economic purpose is for the customer to acquire
ownership of the goods. This is to be identified by
looking at the interests which performance of the contract
satisfies; or, as I suggested in argument (a suggestion
adop ted by Mr Prosser) by looking at what the contract is
designed to achieve: compare the formulation in sch 4
para 1(2)(b) of VATA which refers to “ agreements which

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

… contemplate that the property … will pass” (although
this has its own difficulties: see bel ow).
49. In the case of the equal instalment HP agreement, it is
easy to see that this test is satisfied. Although there is no
legal obligation on the customer to exercise the option to
purchase, performance of the contract will in fact lead to
the cust omer paying MBFS the entire purchase price of
the vehicle together with interest over 3 years, at the end
of which he is able to acquire the ownership of the vehicle
for a minimal fee. One does not need to examine the
marketing material, or the subjective intentions of the
parties, to see that the interests which performance of the
contract satisfies are (i) the customer’s interest in being
able to finance the acquisition of a vehicle by having 3
years to pay the purchase price by instalments, with
interes t on the reducing balance, and then being in a
position to acquire the vehicle at no extra cost (beyond a
minimal fee) and (ii) MBFS’s interests in receiving the
purchase price, together with interest, and having security
for payment in the shape of retent ion of ownership until
the price has all been paid. Put another way, the contract
is designed to achieve sale of the vehicle to the customer
with the customer being given time to pay and MBFS
being given security; the structure of the contract is such
that it can be said that it contemplates that property will
pass. Such a contract would appear to be the paradigm
example of a contract within Art 14(2)(b): indeed, as
Mr Thomas said, if HP contracts are not within the first
limb of Art 14(2)(b) it is very d ifficult to see what sort of
contract might be.
50. Equally in the case of the balloon type of HP agreement.
As I have said it was not disputed by Mr Prosser that such
a contract would fall within Art 14(2)(b), and I agree.
Here too performance of the contract will lead to the
customer paying the entire price of the vehicle by the end
of the 3 year period, and it seems to me that the interests
of the parties which performance of the contract will
satisfy are the same.
51. This is so even though (assum ing the agreement is a
regulated one) the customer has a right to terminate the
contract early; and even though as a matter of fact a
significant number of customers exercise this right. This
is not because, as Mr Prosser at one stage submitted, the
right to terminate is a right under statute rather than under
the contract. I do not think this makes any significant
difference: the agreement itself refers prominently to the
right to terminate, and as Mr Thomas said even if the

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

rights are statutory they for m part of the terms on which
the transaction takes place. It cannot matter whether the
statute is regarded as directly modifying the terms of a
contract, or as giving a statutory right outside the
contract: the effect is the same, which is that a customer
under a regulated agreement has a right to terminate it
early on payment of the specified amount.
52. Rather in my judgment the reason why early termination
rights do not prevent the contract being one within Art
14(2)(b) is because the exercise of a rig ht to terminate the
contract early is not a performance of the contract, but a
means of avoiding performance. In other words when
asking the question what are the interests of the parties
that performance of the contract satisfies, one assumes
that the co ntract will be performed, not brought to an
early end, even if early termination is lawful rather than a
breach of contract. I derive this simply from the way in
which Advocate General Tizzano describes the task of
finding the contract’s economic purpose; but it is also
reinforced by the wording of Art 14(2)(b). If one is
asking what a contract provides for “in the normal course
of events” this in my judgment requires assuming that the
contract will be performed, not prematurely terminated.
…..
63. For the reasons I have given above, I accept Mr Prosser’s
submission that the FTT made an error of law in their
interpretation of Art 14(2)(b). It is not sufficient for a
contract to come within Art 14(2)(b) for it to contain a
provision under which the hirer has an option to acquire
the ownership of the vehicle at the end of the hire period,
and that such acquisition is a normal outcome. In order
for a contract to come within Art 14(2)(b) it must be the
normal outcome of the contract, this being determined i n
accordance with the guidance given by Advocate General
Tizzano by reference to the economic purpose of the
contract, that is by looking at the parties’ respective
interests which performance of the contract satisfies.
…..
78. Before coming to the FTT’s f indings in detail, I should
say that I myself would have no difficulty in accepting
both Mr Thomas’s and Mr Prosser’s characterisation of
the contract as correct. Mr Thomas is plainly right that
the Agility contract is a method of purchasing a vehicle.
By paying all the contractual instalments, the customer
does acquire the right to buy the vehicle. By that stage he
has already paid the deposit (if there is one) and, by

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

means of the monthly instalments, has also paid off a
substantial part of the purchas e price (in the examples
given in paragraph 13 above either 57.5% or 51.4%),
leaving a residual payment to be made. As Mr Thomas
submitted, in this respect it is very similar to the balloon
type of HP contract, where equally the customer by
paying the mon thly instalments acquires the right to
purchase the vehicle and by the final month has paid off a
similar amount of the capital (in the example given in
paragraph 7 above 56%). The only difference is that in
the HP contract the customer is by the terms of the
contract obliged to pay the balloon payment (subject, at
any rate if it is a regulated agreement, to his statutory
right to terminate the agreement); whereas in the Agility
contract the customer is under no obligation to make the
final payment of capi tal as this is structured as the option
payment. As Mr Thomas says this seems a very nice
distinction on which to characterise the Agility contract
differently from the ba lloon type of HP agreement.
79. To that extent it seems to me indisputable that one of the
economic interests which the Agility contract serves is the
interest of the customer in being able to acquire the
vehicle in a more affordable way than paying the full cash
price upfront. Rather than finding, for example, £22,355
for a new C -class car, the customer can pay £516.20 per
month for 3 years and then £11,450. It is easy to see that
this may be a more attractive way of purchasing a car for
some customers; and the (agreed) fact that if a customer
shows no interest in purchasing a vehicle h e is
recommended a Leasing contract also serves to
demonstrate that one of the purposes of the Agility
contract is to enable customers to buy vehicles in this way
if they want to.
80. Equally however for my part I would unhesitatingly
accept that Mr Pross er is right that under an Agility
contract the customer is not committed to the purchase at
the outset. He is not committed legally because the
option to purchase is an option which he is under no
obligation to exercise. Nor would I conclude that he is
committed economically: performance of the contract
requires him to pay the 36 monthly instalments, but still
leaves a substantial payment to be made. It does not seem
at all a foregone conclusion that the customer will in fact
exercise the option. The op tion payment is calculated to
be equal to the anticipated residual value of the vehicle;
but the actual value of the vehicle after 3 years will
depend on the then state of the market for second -hand
Mercedes vehicles which may not be as predicted. So

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

there is no guarantee that it would make economic sense
for the customer to exercise the option. But even if the
vehicle is then worth its anticipated residual value, it is
not difficult to see that some customers might not have
£11,450 readily available; or might prefer in any event to
start a new contract paying several hundred £ a month for
a new vehicle rather than laying out over £10,000 for a 3 –
year old one.
81. In these circumstances, I would myself have no difficulty
in accepting that another of the ec onomic interests which
the contract serves is the interest of the customer in being
able to choose, 3 years down the line, whether to
complete the purchase of the vehicle or whether to forego
that opportunity. The fact that many of the customers (on
avera ge 50%) do not in fact acquire the vehicle would
appear to show that this is a real, and not merely
theoretical, interest.
…..
104. Mr Thomas summarised his case on the facts as being that
the FTT was entitled to come to the view that the Agility
contrac t had features which supported the analysis that
the economic purpose of the transaction was a sale of
goods. For reasons already given I have no difficulty
with the proposition that one of the purposes of the
contract was to enable the customer to purcha se the goods
in a more affordable way than buying them outright. But
this is not a complete or adequate description of the
economic interests which performance of the contract
serves. The contract also serves to give the customer a
(real and not illusory ) choice after 3 years whether to
proceed with the purchase or return the vehicle, together
with provisions designed to protect MBFS in the event
that the customer chooses not to purchase the vehicle.
This seems to me the true and only reasonable conclusi on
from the facts and I have been unable to find anything
which would justify the FTT’s apparent factual findings
to the contrary.
105. Mr Thomas also submitted that the economic reality of
the Agility contract was indistinguishable from that of the
balloo n type of HP contract. The only difference between
them was that in the HP contract, the balloon payment
was one that was due under the contract (but which in the
case of a regulated agreement the customer could in
practice avoid paying by exercising his statutory right to
terminate the contract early) whereas in the Agility
contract the customer had a contractual right not to pay
the balloon payment. This was, he said, too fine a

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

difference to affect the characterisation of the contract.
There is undoub tedly some force in this point, but in the
end the question remains what is the economic purpose of
the Agility contract in the sense explained by Advocate
General Tizzano.
106. As explained above, the economic purpose of the contract
is to be found by i dentifying the precise way in which
performance satisfies the interests of the parties, and I
have already set out the way in which the Agility contract
satisfies the interests of the parties (see paragraphs 79 to
83 above). In summary it does so by affor ding the
customer an opportunity to purchase but without
committing him to do so, and by giving MBFS a return on
the finance it provides in circumstances where either the
vehicle will be purchased or it will be returned at no risk
to MBFS.
107. I do not think this can be characterised as in effect a
contract for sale of the vehicle. It is a contract which may
well lead to a sale of the vehicle but equally may well not.
In line with the views I have expressed above as to the
scope of Article 14(2)(b), it is not in my judgment a
contract under which ownership is to pass in the normal
course of events .”
The grounds of appeal
16. HMRC’s primary challenge to the reasoning of the Upper Tribunal is directed at its
adoption of the test of economic cause as the corre ct principle to be applied in relation
to the meaning and effect of Article 14(2)(b). Advocate Tizzano ’s opinion was
delivered in the context of two references from the English High Court concerning the
interpretation of the phrase “the Leasing or letting of immovable property” in Article
13B( b) of the Sixth Directive which provides for various exceptions from VAT:
“13B. Without prejudice to other Community provisions,
Member States shall exempt the following under conditions
which they shall lay down for the purpose of ensuring the
correct and straightforward application of the exemptions and
of preventing any possible evasion, avoidance or abuse:”
…
(b) the Leasing or letting of immovable property ….”
17. Mr Thomas submits that in order to determine whether a contract amounted to the
Leasing of immovable property it was perfectly understandable to articulate a test of
economic purpose which c ould be operated across all member states regardless of the
idiosyncrasies of national laws on the subject. But the s ame approach, he says, is
inapplicable in the context of Article 14(2)(b) where the issue is not the
characterisation of a particular type of contract (e.g. whether the cont ract is a lease of

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

immovable property or, in the present context, a contract for th e hire of goods) but
how effect should be given to a deeming provision which is designed to treat as
supplies of goods contracts which would not satisfy the provisions of Article 14(1):
i.e. would not (whether as a matter of economic analysis or otherwise) amount to a
transfer of the right to dispose of the tangible property as owner.
18. The argument for HMRC is that the economic cause is simply the wrong tool to use in
order to decide whether a contract which does not qualify under Article 14(1) can
neverthel ess be treated as a supply of goods because it contains terms under which “in
the normal course of events” ownership will pass. The characterisation of the contract
is a prior question which determines whether the contract falls into Article 14(1) or
Article 14(2)(b). If the answer is that it falls into the latter then the question whether
is satisfies the 14(2)(b) test is not one of economic cause but simply a consideration
and analysis of the terms of the contract.
19. HMRC’s second ground of appeal is that even as a matter of economics there were no
good grounds for distinguishing between the HP balloon contract and the Agility
contract. Although the Agility contract does not require the customer to pay the
balance of the purchase price and interest as par t of the final instalment unl ike in the
case of the HP balloon contract, there is a statutory right of cancellation under the
balloon contract which effectively creates the same level of optionality as exists under
the Agility contract.
20. The Upper Tribunal distinguished the two by treating the right to t erminate not as part
of the performance of the balloon contract but rather as a means of avoiding
performance: see [52] of the Decision. But , say HMRC, this in fact ignores the
economic congruity between the two types of contract and is therefore inconsistent
with the Upper Tribunal’s own determination of the principle to be applied to
determine the operation of Article 14(2)(b) .
21. Ground 3 of the appeal is that the Upper Tribunal’s application of the economic
purpose test effectively re -writes Article 14(2)(b) and disregards its essentially
contingent nature. Although the final instalment of the purchase price is defined as an
optional payment under the Agility contract, it is no different in this respect from any
other regulated HP agreement, none of which commit the customer to purchase the
goods or (because of the right of termination) to pay the full price of the goods.
22. For this reason, HMRC contend that the only satisfactory approach consistent with the
need for legal certainty is to treat all contracts which contemplate that property will
pass at the latest upon payment of the final instalment as falling within Article
14(2)(b). For this purpose, the optionality or not of paying the full price which is th e
only contractual distinction between the HP balloon and the Agility contracts is
immaterial. In each case title “is to pass” upon the exercise of the options following
the making of the final payment.
23. HMRC’s f ourth ground of appeal is that the Upper Tri bunal failed t o pay due regard
to the princip le of legal certainty. In its submissions to the Upper Tribunal
Mr Thomas contended and Nugee J seems to have accepted that an interpretation of
“in the normal course of events” which imported a t est of what wa s likely or expected
would be unworkable. But the Upper Tribunal’s formulation of the economic purpose

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

test as turning on the “normal outcome of the contract” (see [63] quoted earlier) in
effect re -introduces a probability based test.
24. HMRC point out the d ifficulties which they say a tax authority will have to determine
in a consistent, fair and predictable way whether a hire contract containing an option
to purchase does or does not have the economic purpose of “committing” the
customer to a purchase of th e vehicle: see [106] of the Decision of the Upper
Tribunal. By contrast, the interpretation of Article 14(2)(b) proposed by HMRC
would, they say, permit the easy determination of that issue simply by reference to the
existence of the option and the terms upon which it is exercisable.
25. The final ground of appeal relates to what the Upper Tribunal sa id in [42] about the
policy pur pose behind Article 14(2)(b). Mr Thomas submitted that this part of the
Upper Tribunal’s reasoning is circular because there was n o evidence before the
Upper Tribunal as to what Article 14(2)(b) was intended to achieve and the Upper
Tribunal has therefore derived the policy purpose from its interpretation of the
language of Article 14 itself.
A reference
26. The Upper Tribunal declined t o refer the in terpretation of Article 14(2)(b ) to the
CJEU. In our view, it was wrong not to do so. In the absence of any direct guidance
about the interpretation of Article 14(2)(b), we have reached the conclusion that the
issue is not acte clair . Having heard the arguments of Mr Thomas and of Mr Prosser
QC for MBFS, we therefore indicated to them that we proposed to make a reference.
It seems to us that although Article 14(2)(b) is directed in terms to what the relevant
contract of hire provides, ther e is much less certainty as to whether the qualifying
phrase “in the normal course of events” requires a tax authority to do no more than to
identify the existence of an option which is not exercisable later than upon payment of
the final instalment or to go further and determine the economic purpose of the
contract in accordance with the test outlined by Advocate General Tizzano in his
opinion in the Mirror Group case.
27. We therefore require guidance from the CJEU as to whether that is the appropriate
test to adopt and, if not, what is the correct interpretation and application of Article
14(2)(b). We envisage that as part of the reference the Court will consider HMRC’s
argument about timing on which we have not heard full argument but which seems to
us to have some obvious attraction in terms of legal certainty.
28. Once this judgment has been made available to the parties, we will invite the parties
to liaise with the Court with a view to agreeing the questions which will be contained
in the reference.
Crown c opyright©

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

APPENDIX
4. I propose first to give a brief account of the facts which were either agreed, or
apparent from the terms of sample agreements in evidence before the FTT, or
otherwise not disputed, without at this stage dealing with those factual f indings of the
FTT that are criticised in MBFS’s appeal. I do not propose to set out the entirety of
the Statement of Agreed Facts which were agreed by the parties for the FTT hearing:
they can be found set out in the Decision at [30] -[44].
5. MBFS is a subsidiary of Daimler AG. It offers financial products to its customers.
Since 1 August 2007 when Agility was launched, the three options given to the
customer are “Hire Purchase” ( “HP” ), “Agility” and “Leasing” contracts. Under
each of them, the cus tomer obtains the use of a Mercedes Benz vehicle and makes
monthly payments to MBFS for a specified period; under HP and Agility the
customer also has the option at the end of the period to acquire the vehicle. If a
customer has decided at the outset that they would like to purchase the vehicle, an HP
product may be recommended; if they have decided they do not wish to, a Leasing
product will be recommended; if they are undecided or would like to keep their
options open, the Agility product will be recomme nded.
6. Sample agreements of each of the three types were put before the FTT. The simplest
is the Leasing agreement. This is described as a “Hire Agreement regulated by the
Consumer Credit Act 1974”. The particular example in evidence was for the hire of a
new Mercedes -Benz LCV Sprinter 3 (a type of van) for a period of 36 months, with
equal monthly rental payments due of £435.42 a month. The agreement contains no
option to purchase the vehicle, and at the end of the 36 months the customer is
obliged to return it to MBFS. If the vehicle has travelled more than a specified
allowed distance, the customer will become liable for an excess distance charge. The
customer is also obliged to keep the vehicle properly maintained in accordance with
the manufact urer’s recommendations and the agreement contains a detailed statement
of “vehicle return standards” specifying the condition that the vehicle should be in
when returned. It is common ground that this agreement does not constitute a supply
of goods for VA T purposes, but is a supply of services.
7. The HP Agreement takes the form of an agreement for hire with an option to purchase
at the end of the hire period, exercisable for a small fee called an “Option to purchase
fee”, typically of £95. Some HP agreem ents provide for equal monthly payments:
one of the sample agreements in evidence (described as a “Hire Purchase Agreement
regulated by the Consumer Credit Act 1974”) was for the hire -purchase of a
Mercedes -Benz C -Class car where the amount of credit was £ 23,555 and the
payments due were 36 equal monthly instalments of £791.00. Other HP agreements
provide for lower monthly payments for the first 35 months with a substantial
“balloon” payment due as the final monthly payment: the example in evidence (also
described as a “Hire Purchase Agreement regulated by the Consumer Credit Act
1974”) was for the hire of a Mercedes Benz LCV Vito van with a total cash price of
£18,517.45 of which £2,415.32 (13%) was to be paid by way of deposit, leaving just
over £16,000 t o be financed. This was payable by 36 monthly payments of £328.31
(totalling £11,815.56, made up of £7,957.13 capital (43%) and £3,858.43 interest),
together with a balloon payment of £8,145 (44%) payable with the final instalment.
Although not directly comparable with the first example (as the capital financed is

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

much lower), it can be seen that the effect of the balloon payment is to reduce the
monthly payments significantly. Being agreements regulated under the Consumer
Credit Act 1974 ( “CCA” ), the ag reements specify certain financial information on
their face including the amount of credit, the APR, the total payable, the total cash
price of the vehicle and the total charge for credit.
8. The HP agreement is drafted on the basis that the customer is obliged to make all the
monthly payments, including the balloon payment if there is one. It does not oblige
the customer to pay the £95 Option to purchase fee, but if the customer has made all
the contractual payments, he would by the end of the contract period have paid the
entire cash price of the vehicle so it would make commercial sense for him to pay the
£95 to acquire the vehicle.
9. However if the agreement is a regulated agreement (as the example agreements in
evidence were), then the CCA gives the customer certain statutory rights. One of
these is the right to terminate the agreement. If this right is exercised, the maximum
that MBFS can claim is half the total amount that would be due under the agreement,
so if this has already been paid, no mor e is payable: see ss. 99 and 100 of the Act.
The HP Agreement contains a notice of these rights as follows:
TERMINATION: YOUR RIGHTS
You have a right to end this agreement. To do so, you should write to the
person you make your payments to. We will then be entitled to the return of
the goods and to half the total amount payable under this agreement, that is
£….. If you have already paid at least this amount plus any overdue
instalments and have taken reasonable care of the goods, you will not have to
pay any more.
10. The HP Agreement obliged the customer to keep the vehicle properly maintained in
accordance with the manufacturer’s recommendations, and if the agreement was
determined (either by the customer, or by MBFS on the customer’s default) then t he
customer could be liable to compensate MBFS if the vehicle was not returned in good
condition, repair and working order; but there was no annexed statement of vehicle
return standards as there was with the Leasing agreement. Nor was there any allowed
distance specified, or obligation to pay an excess distance charge if it were exceeded.
11. It is common ground between the parties that an HP agreement, whether of the equal
instalment type or of the balloon type, is a supply of goods for VAT purposes,
although they do not agree on the reason why this is so.
12. The Agility agreements in evidence have some similarities to both the Leasing
agreement and the HP agreements. Like the HP agreements, they are described as a
“Hire Purchase Agreement regulated by the Consumer Credit Act 1974”, and contain
a period of hire of 36 months with an option to purchase thereafter; and, being
regulated agreements, they contain a notice of the customer’s rights including the
right to early termination, and a statement of fin ancial information including the
amount of credit, the APR, the total amount payable, the total cash price of the vehicle
and the total charge for credit. Like the Leasing agreement, the Agility agreements
contain a specified allowed distance and require the customer to pay an excess
distance charge if the vehicle is returned having travelled more than the allowed

Judgment Approved by the court for handing down. HMRC v Mercedes -Benz Financial Services UK Ltd

distance; and a detailed list of vehicle return standards against which the condition of
a vehicle would be measured if returned.
13. The struct ure of the payments under an Agility agreement is as follows. Unlike the
HP agreement, the payment due on exercising the option to purchase (called the
“Optional Purchase Payment”) is a substantial payment. It is calculated to be equal to
the anticipated market value of the vehicle at contract maturity (taking into account
the anticipated mileage), or “residual value”. Since there is a considerable demand
for second -hand Mercedes -Benz vehicles, the residual value is a substantial
proportion of its initia l value: the first example in evidence is of an LCV Sprinter with
a cash price of £22,325.00, a deposit of £3,325 (15%) and an Optional Purchase
Payment of £9,500 (42.5%). The monthly payments are then set to pay off the
difference between the cash price (less deposit) and the residual value, together with
interest. In this example this leads to 36 monthly payments of £373.35 (totalling
£13,440.60 of which £3,940.60 is interest and £9,500 the balance of capital). The
corresponding figures for the second example (a C -Class car) are cash price of
£23,555, deposit of nil, Optional Purchase Payment of £11,450.00 (48.6%), and 36
monthly payments of £516.20 totalling £18,583.20 (of which £6,478.20 is interest and
£12,105 the balance of capital (51.4%)). If the option to purchase is exercised, a fee
of £95, called the Purchase activation fee, is payable as well as the Optional Purchase
Payment.
14. If an Agility customer does not exercise the option to purchase, the vehicle is returned
to MBFS. MBFS has a guara nteed buyback agreement with a sister company which
owns the used car network in the UK. This means that MBFS can dispose of the
returned vehicles at retail value and does not take any risk on “the metal” . MBFS is
therefore neutral as to whether an Agili ty customer exercises the option or not. 3
months before the end of the contract, MBFS sends the customer a “Maturity Pack”
asking them if they wish to return the vehicle, purchase the vehicle outright or
purchase the vehicle and use it as a deposit for a new vehicle. The percentage of
Agility customers returning their vehicles on maturity rather than purchasing them has
fluctuated from about 25% to about 75%, with an average percentage of 50%.
15. HP customers are not sent the same list of options on m aturity. The “Welcome Pack”
which they are given at the outset of the contract tells them that the “Option to
Purchase” fee will be debited from their account in the last month, and that “once
you’ve made all your payments, your Mercedes -Benz is yours to keep”; the option fee
is taken by direct debit.
16. The FTT found as a fact that there was a similar high rate of return under HP
agreements as under Agility agreements relying on what Mr May, who was the former
Chief Financial Officer of MBFS and who g ave oral evidence before the FTT, had
said. In its Grounds of Appeal MBFS asserted that this was incorrect and based on a
misunderstanding of Mr May’s evidence; but there is no note of the oral evidence and
Mr Prosser QC, who appeared for MBFS, accepted t hat there was no material before
me on which I could reject this finding of the FTT.