Understanding the VAT reverse charge is essential for businesses buying and selling goods or services cross-border in the EU
Ryan Bevan 18 April 2016 No comments
VAT Reverse Charge Explained.
Virtually all of our clients have an ‘international’ dimension to their business whether they are buying goods or services from other EU Member States or moving their own products to/from fulfilment centres around Europe. In doing so, this means at some point the VAT reverse charge or VAT ‘self-assessment’ comes in to the equation. The reverse charge is often overlooked and are not processing on submitted VAT Returns meaning Tax Authorities are now placing more and more emphasis on getting it right.
Here we explain what the ‘reverse charge’ is and how it applies.
So, what is the VAT reverse charge?
The VAT reverse charge is at its simplest a mechanism where the liability to account for and pay VAT on cross-border services is transferred from the supplier to the receiver of certain services. It is important to note that reverse charge only applies to Business to Business (B2B) transactions and when services are supplied. B2C transactions are not subject to the domain of the reverse charge and the intra-EC supply of goods, known as acquisitions, is subject to a similar reverse charge mechanism whereby the obligation for reporting the VAT shifts to the recipient.
And … how does it work?
The reverse charge acts in the way that the customer is treated as if they made the actual supply themselves and consequently is obliged to self-assess for the application of output VAT at the appropriate rate to the supply, thus increasing the amount of VAT payable on the VAT Return. Simultaneously as per the normal VAT recovery entitlement of VAT registered businesses, that business may claim an input VAT credit for the self-assessed output VAT on the same VAT Return – this creates a notional VAT charge and the ensures the business receiving the supply is in a VAT neutrality position.
Provided a business has full VAT recovery entitlement (the input VAT is not ‘blocked’ or are partially or fully exempt) then the net effect of increasing the output VAT on the sale and the input VAT on the purchase will be ‘nil’ and the transaction will be deemed as VAT neutral.
For example, a marketing agency are VAT registered in the UK only and provide their services to a wholesaler of clocks who are VAT registered in Ireland. The marketing agency would apply the UK zero-rate of VAT to their supply on its invoice to the Irish wholesaler. The Irish wholesaler would pay the Irish Revenue the self-assessed VAT on the service provided at the 23% VAT rate in Ireland. Additionally, the Irish wholesaler would also claim a credit for the notional output VAT self-assessed and claim back the 23% output VAT charged as input VAT
[N.B. Diagram below assumes £1=€1 exchange rate for simplicity].
Click on the image to see full-size example diagram
Why have the VAT reverse charge?
The reverse charge mechanism is a solution that many businesses utilise to their advantage to avoid multiple VAT registrations in EU Member States where that business is not VAT registered in the region of the purchaser. In the example above, the UK marketing company are not VAT registered in Ireland and the clock wholesaler is not VAT registered in the UK.
In cases like this, the VAT must be accounted for somewhere. So, under the place of supply rules for VAT purposes, the VAT on the sale is shifted to the recipient’s country and the recipient will report and pay the VAT to make it seem as though the UK sales and marketing company were VAT registered in Ireland. The tax shift taking place under the reverse charge mechanism helps the UK company by not having to register for VAT in Ireland and reduces their VAT compliance obligations and simultaneously the Irish Revenue are receiving the 23% output VAT that would have been due if the supply would have been provided by an Irish company VAT registered in Ireland.
The reverse charge mechanism also aims to ensure fiscal neutrality across all EU Member States. The tax shift aims to prevent an EU Member State from obtaining a competitive advantage over another through variances in VAT rates – each EU Member State has a different rate of VAT that can be adjusted – the reverse charge essentially puts a company in the position as though it were receiving the supply domestically rather from a company in another EU Member State. This helps to ensure fiscal neutrality and non-competition amongst Member States by disregarding the VAT rate in the supplier’s country. Without this in place or if the supply of services is charged at the supplier’s VAT rate rather than the recipient’s VAT rate, it may be the case that many companies establish themselves and provide their services from the EU Member States with the lowest VAT rates, giving them a competitive advantage cross-border over any competitors in EU Member States with a higher VAT rate.
A significant impact of the reverse charge mechanism is that VAT fraud has become more difficult to get away with. Previously some fraudulent companies would try and take advantage of the VAT process through means such as Missing Trader ‘MTIC’ carousel fraud. However by making the recipient of certain services pertaining to the reverse charge account for both sides of the application of VAT, then the reverse charge acts as an effective anti-fraud device.
It is important to note that not all intra-EU services are subject to the reverse charge; these are known as services that fall under ‘exceptions’ to the VAT place of supply rules. If your business is unsure of how and when to deal with VAT on international transactions, please get in touch with one of our European VAT experts – we’ll be pleased to help.
(All figures and rates accurate at the time of posting.)