Rental, lease and ICA agreements – Don’t take your eye off the VAT aspect

In this short series of articles, we deal with the VAT considerations when entering into rental, lease and installment credit agreements.

Introduction

In practice confusion often reigns when VAT vendors enter into instalment credit agreements (ICAs), lease and rental agreements. The root of the confusion can often be traced to the technical meaning attributed to such arrangements for VAT purposes and the commercial classification thereof.

This article deals with the distinction between ICAs, lease and rental agreements.

In the next article we shall deal with the VAT rules attaching to each.

What are ICAs?

The good news is that ICA’s and financial leases are both regarded as ICAs for VAT purposes resulting in a single set of VAT rules applicable to both.

In practice ICAs and financial lease agreements often have a lot in common with rental agreements, hence the confusion.

The classification of the various agreements is by no means simple, and the devil, as always, is in the detail.

Let’s dive in …

An ICA for VAT purposes

Agreements for the use of goods is a classic example of a name given to something causing unfortunate consequences and confusion. In essence one has to determine whether an ICA is an ICA!

To determine whether an ICA for commercial purposes is an ICA for VAT purposes, various tests must be applied.

Let’s start at the very beginning …

For starters, an arrangement can only constitute an ICA if it relates to moveable goods or machinery or plant (plant may include immovable property).

But wait, there is more …

The seller must sell the goods to the purchaser for a sum of money payable in whole or in part in instalments over a period in the future (the price and payment tests), and

The sum of money must include finance charges stipulated in the agreement, (the finance charges test), and

The total amount payable by the purchaser to the seller must exceed the cash value (capital value) of the goods (the total consideration test), and

The purchaser must not become the owner of the goods merely by virtue of the delivery to or the use, possession or enjoyment thereof, or

The seller must be entitled to the return of the goods if the purchaser fails to comply with any term of the agreement (repossession clause) (the ownership test).

If the supplier can tick all the boxes, the arrangement is an ICA!

Let’s proceed to the second category of ICA’s …

Financial lease agreements

As with an ICA, the lease agreement must relate to the supply of moveable goods, or machinery or plant (whether or not movable).

And here comes the detail …

The arrangement must comply with all the requirements set out above for ICAs, as well as the following additional requirements.

The rental agreement must be for a period of at least 12 months (the use period test), and

The lessee must either accept the full risk of destruction or loss of the goods and be responsible for the insurance, maintenance and repair of the goods while the lease agreement remains in force or accept the full risk of destruction or loss of and assumes all obligations in connection with the insurance, maintenance and repair of the goods or must reimburse the lessor for the insurance of the goods where the lessor pays for the insurance (the risk of ownership test).

If you can tick all the above boxes, you have an ICA!

Rental agreements

Rental agreements for VAT purposes are all use agreements that do not qualify as ICAs for VAT purposes.

Summary

This article deals with the distinction between ICAs and rental agreements. In the next article we shall deal with the specific VAT rules applicable to each category of supply.