VAT upon early termination of financial leases

Recent CJEU case law has confirmed that amounts charged upon the early termination of financial leases do not always have be viewed as supplies not subject to VAT. This applies even to payments previously defined in contracts as damage compensation, contractual penalties or financial settlements. It is not yet clear what course the Czech tax administration will take. Financial lease companies and others who charge these fees to their customers should review the VAT treatment they apply.

In July, the CJEU issued judgment C-242/18 in the UniCredit Leasing (Bulgaria) case dealing with a correction of VAT paid on unpaid lease instalments.

In this context, the court also opined on applying VAT on amounts paid upon the early termination of a contract, which it viewed as part of the overall supply. The court had already previously dealt with similar issues (for instance, see judgment C-295/17 in MEO case,) and it seems that its case law is consistent. In the UniCredit Leasing case, the court mainly pointed out the existence of mutual supplies constituting a direct link between the service provided (the lease) and the consideration received. The duty to pay compensation upon early termination was an inseparable component of the lease contract when it was first concluded. The payment of this amount in effect allowed the lease company to gain the same revenues it would have gained had the contract not been terminated. From this, the CJEU deduced that a termination does not change the economic reality of a contractual relationship. It also noted that it was not relevant whether the user, having terminated the contract, continued to dispose of the subject of the lease (as the lease company provided the user with an option to continue to use the supply under the contract).

The CJEU thus concluded that an amount to be paid upon the early termination of a contract shall be viewed as an inseparable part of the overall consideration for the supply under the lease contract. As such, it shall be subject to VAT.

In Czech practice, the amounts charged to lessees upon the early termination of financial leases are usually treated as damage compensation or contractual penalties. However, in view of the above CJEU case law, discussions on possible changes in the methodology are now taking place between the Czech Lease Association and the tax administration.