4.5.2.7 The VAT treatment composite supplies where the ‘free’ element has an absolute and relatively high value

Situations exist where the ‘free’ element included in a multiple-element supply represents a considerable value, both in absolute terms as well as in comparison to the other element(s) of the transaction. This could imply that the customer will base his decision to make the purchase (or: engage in that transaction) also, or even mainly, with the aim of obtaining that free element. In other words, the free element is ‘an aim in itself’ for the customer. This means that there is no ‘absorption’ or ‘amalgamation’ and that, as a basic rule, each element should have its own VAT consequences, based on – as a main rule – the legal agreement regarding the supply of that element.

Where the ‘free’ element has an absolute and relative high value, the (typical) customer should not seriously expect that, given the value of the free element, this element is actually supplied to him for free in these cases. The typical customer should consider that the amount of the agreed consideration is also based on the fact that part of it is used for payment of the ‘free’ element. In these cases, the typical customer would be less inclined to pay the same price for the transaction if the ‘free’ element was not included. It could even be clear that most customers would not do that. A (now historic)1 example of such transactions in the Netherlands were telecoms services providers that offered ‘free’ handsets with certain monthly plans/subscription forms. In a Civil Law case, it was decided by the Dutch Supreme Court that for the clients, the new handset generally represented, both in absolute terms as well as in comparison to the amount payable for monthly use of the telecoms services, a significant value.2 As a result, the Dutch Supreme Court stated that it should be assumed that a customer will normally decide to enter into that specific agreement also with a view on obtaining ownership of a new handset. In general, given the value of the handset, the customer will (or should) not expect to actually receive the handset for free. He will have to take into consideration that the agreed monthly instalments also include consideration for the supply of the handset.

In the case of the above example, the price of the composite supply was clearly determined by both elements of the transaction (the telecommunications service as well as the supply of the handset). The price of the service by itself, without the handset, would be significantly lower.3 Under these circumstances (the value of the ‘free’ element, the fact that it is an aim in itself for the customer and the fact that its value significantly affects the agreed consideration for the composite supply), in my view, commercial and economic reality dictates that the element advertised as ‘free’ is actually made for consideration.

Even though the accounting rules proved not to be fully suitable for determining the VAT treatment of multiple-element transactions, applying the perspective of ‘commercial and economic reality’, in the sense of the current FASB rules, it could also be used to argued that the free handset is an ‘agreed deliverable’ rather than a ‘marketing incentive’. This would also suggest that part of the consideration paid for the composite supply should be allocated to this ‘free’ element.

In the earlier example of the vouchers issued by the fuel company, in my view, motorists would not be less inclined to purchase the specific brand of petrol for the advertised price if they would not receive the (vouchers for the) free goods. These free goods might persuade the customer to be loyal to the brand of petrol that provides the vouchers, but they are in my view not an aim in itself for the customers when they make their fuel purchase. Also, even though “there is no such thing as a free lunch”, and the purchasers of the fuel probably understood that part of their payments covered the supply of the ‘free gifts’, no direct link exists between the payments and the supply of the vouchers or the redemption goods. The customers that chose not to accept the vouchers paid the same price for the fuel, which means that they also funded these gifts. Also taking into account the ‘commercial and economic reality’ in the accounting sense, the free redemption goods should be qualified as ‘marketing incentives’ rather than ‘agreed deliverables’, implying that no part of the agreed consideration should be allocated to the supply of the redemption goods.

Accepting a certain price for a supply, whilst understanding that part of the receipts for those supplies will be used for funding free gifts does not constitute a payment for the supply of those gifts. If that were the case, then one could also argue that free lunches served at the headquarters of the petrol company and the yearly Christmas party are also paid for by allocating part of the revenue generated by all petrol sales to these supplies as ‘third-party payments’. This is clearly not the case (from an EU VAT perspective).

Taxpayers should be very aware of the VAT consequences that the above can have. The fact that, in the above example, the payment made for the telecoms subscription should be partly allocated to the supply of the telephone means that the VAT on that part of the consideration that is received or still has to be received will become payable when the right to dispose of the telephone as owner is transferred to the customer.4 A UK court also considered the absolute and relative value of a ‘free’ element of a composite supply relevant in its decision that this element was actually supplied for consideration. This case is described in Section 4.5.2.8.