The rule involves HM Customs & Excise restricting to 50% the proportion of company car hiring or leasing charges that can be declared as a business expense on VAT returns, leading to a reduction in a VAT bill.
This regulation applies where a company car is also used for private purposes and it also frees a business hiring or leasing a car from having to keep records of private mileage, accounting for tax payable on each journey.
The problem with this rule is that it does not comply with standard European Union (EU) VAT directives, even though the European Commission admits it is a 'simplification' designed to help the UK 'combat tax evasion and tax fraud'.
As a result, the British Government has had to apply – every few years – to the Commission and the EU Council of Ministers to be given special dispensation to operate the system. Brussels has so far agreed in 1995 and 2000 to grant the UK derogations from standard European VAT legislation, but the latest authorisation expires on December 31 this year and the Commission has voiced concern about its long-term future.
In a memorandum to EU ministers, Brussels has warned that an ECJ ruling requested by Germany's federal finance court could effectively ban the UK system. German and EU judges are examining the legality of a broader German practice, which limits to 50% deductions to VAT charged on all expenditure relating to vehicles (including purchase, hire and running costs).
The Commission note said: 'The outcome of this preliminary ruling might therefore be of considerable importance for the question of whether such (UK) measures could be authorised in future.'
It has asked ministers to only extend the British VAT simplification system for one more year. A similar decision was made earlier this year regarding the German system, which also needs special dispensation.
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