THE UK leasing industry can breathe a sigh of relief following HM Customs & Excise's failure to establish leasing companies' liability for their customers who exploited a loophole in VAT regulations in the run up to the August 1, 1995 changes.

Through innovative commercial practices certain fleets enjoyed a double benefit from the changes in the VAT treatment of leased cars. Under a 'pre-let' scheme, these organisations prepaid their lease rentals to an in-house, captive leasing company prior to August 1.

They then recovered 100% VAT on the rentals, as they were entitled to do in line with the tax regulations at the time. But the captive leasing operation contracted to lease cars from an outside leasing company after August 1, 1995. In this way they took full advantage of the new tax regulations which allowed leasing companies to recover VAT on qualifying cars - ie those bought to lease to customers.

Customs had intended to introduce a tax neutral system, by blocking 50% of fleets' VAT recovery on lease rentals, but the pre-let cars escaped VAT on both their purchase price and the rental. This left Customs with a shortfall in its VAT revenue, and prompted it to attempt to recover its loss from the outside leasing company.

At a test case heard by a VAT tribunal, Customs tried to prevent BRS Car Lease from reclaiming VAT on qualifying cars if they were being supplied into a pre-let scheme. BRS successfully argued that it had no knowledge of its customers' 'pre-lets', and could not be held responsible for the VAT shortfall.