Value Added Tax (VAT) is a tax on goods and services charged at each stage of production and distribution. It is collected by HM Revenue and Customs (HMRC). VAT registered businesses charge VAT on their sales and are entitled to reclaim the VAT they’ve paid on purchases. The standard VAT rate is currently 20%.
VAT can sometimes be complex for businesses to manage. One area that causes confusion is when VAT needs to be reversed or reclaimed. This article will explain what reverse charging VAT means and when it applies.
What is a VAT reverse charge?
A VAT reverse charge shifts the responsibility for paying VAT from the supplier to the customer. Under normal VAT rules, a business adds VAT to its sales invoices and pays this VAT to HMRC. With a reverse charge, the business does not collect and pay the VAT to HMRC. Instead, the customer is required to report and pay the VAT.
A VAT reverse charge usually applies when services are purchased from suppliers outside the UK. It is a way to make sure VAT is properly accounted for on services sold in the UK by overseas businesses. If the reverse charge did not apply, overseas businesses could avoid paying UK VAT.
When does a VAT reverse charge apply?
There are two main situations when a VAT reverse charge must be applied:
- Purchasing services from overseas suppliers outside the EU
- Receiving building and construction services from subcontractors inside the UK
Let’s look at each of these in more detail:
1. Services from suppliers outside the EU
If a UK business purchases services from a supplier based outside the EU, it must operate a VAT reverse charge. Some examples include:
- Consultancy services
- Legal and accountancy services
- Advertising services
- Website design services
As the customer is consuming the service inside the UK, UK VAT must be paid. But as the supplier is not UK VAT registered, the responsibility shifts to the UK business receiving the service.
2. Building and construction services
A domestic reverse charge applies for some building and construction services when supplied between subcontractors in the UK. This includes services such as:
- Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures
- Constructing, altering, repairing, extending, demolishing of any works forming, or to form, part of the land
- Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems
- Internal cleaning of buildings
- Painting and decorating interior or exterior surfaces of buildings
The aim of this domestic reverse charge is to tackle VAT fraud in the building sector. It avoids the need for complex VAT invoices down long supply chains of contractors and subcontractors.
How does a VAT reverse charge work?
When a VAT reverse charge applies, the usual process of invoicing VAT on sales is reversed:
- The supplier issues a normal invoice, without VAT added
- The customer accounts for and pays the VAT to HMRC instead of the supplier
So the supplier does not collect and pay over any output VAT to HMRC. And the customer self-accounts for VAT as input and output tax simultaneously. This VAT can be reclaimed as input tax, if the customer is VAT registered.
To report the reverse charge VAT, the customer must:
- Include reverse charge purchases and sales in their VAT return
- Complete all the normal VAT return boxes, including the reverse charge boxes
- Remember to keep invoices and other records of reverse charge transactions
Can you reclaim reverse charge VAT?
If the customer is a business that is VAT registered, they can recover the VAT accounted for under a reverse charge. The input VAT is claimed in the normal way through the VAT return.
The VAT reverse charge does not create any additional VAT cost for the customer. It only changes the responsibility for accounting for and paying the VAT to HMRC.
However, if the customer is not VAT registered, then the reverse charge VAT cannot be reclaimed. It becomes a real cost for the business.
Examples of how the VAT reverse charge works
Here are some examples illustrating how the VAT reverse charge works in practice:
1. UK business buys marketing services from Australia
- UK business buys £10,000 of marketing services from an Australian firm
- The Australian firm issues an invoice for £10,000 without VAT
- The normal 20% VAT on £10,000 is £2,000
- The UK business accounts for £2,000 VAT as a reverse charge
- The UK business claims £2,000 input VAT on its next VAT return
2. Builder buys cement from subcontractor
- Builder buys £5,000 of cement from a UK subcontractor
- The subcontractor issues an invoice for £5,000 (without VAT)
- The VAT at 20% on £5,000 is £1,000
- Builder accounts for £1,000 VAT as a domestic reverse charge
- Builder claims £1,000 input VAT on its next VAT return
What if you forget to reverse charge VAT?
If a business forgets to reverse charge VAT, it could find itself in trouble with HMRC. Some key problems include:
- The output VAT has not been accounted for or paid to HMRC
- The business cannot reclaim input VAT it has not reverse charged
- Penalties and interest could apply for late paid or missing VAT
To correct this, the business should contact HMRC and seek to voluntarily disclose the missing reverse charge VAT. Provided HMRC is told before they identify the issue, penalties may still be avoided.
Going forward, businesses must remember to check if suppliers should be reverse charged. Reviewing procedures and adding reminders to accounting software can help avoid similar errors.
Can you reverse charge VAT to reduce costs?
Some businesses wonder if they can voluntarily reverse charge VAT when buying from UK suppliers. This would shift the VAT cost to them rather than their suppliers.
However, the VAT reverse charge mechanisms are specifically defined in UK law. They only apply for purchases from outside the EU or on certain construction services.
A UK business cannot choose to reverse charge VAT when buying goods or services from other standard-rated UK suppliers. Doing so would breach VAT rules and could cause problems with HMRC.
How to prepare your business for VAT reverse charges
Making sure your business is ready for VAT reverse charges will avoid any nasty surprises. Some tips include:
- Check purchases and identify any high risk supplies, e.g. from overseas
- Review invoices from suppliers to spot where a reverse charge applies
- Update your accounting systems and software to handle reverse charge supplies
- Train staff on reverse charge procedures and documentation
- Factor in the cash flow impact of paying output VAT up front
- Get advice from your accountant if you are unsure
Pros and cons of VAT reverse charges
Reverse charging VAT has advantages and disadvantages for businesses:
Advantages
- Increased cash flow – VAT is not paid until the VAT return
- Easy to reclaim input VAT for VAT registered businesses
- Can help tackle VAT fraud in some sectors
Disadvantages
- More responsibility to account for VAT correctly
- Upfront cash flow impact of reporting output tax
- Extra procedures and administration to manage
- Unreclaimable VAT cost if business is not VAT registered
Is there ever VAT on reverse charge invoices?
Reverse charge invoices should never include any VAT. The whole point is the supplier does not charge or collect VAT on such supplies.
However, sometimes suppliers make mistakes and add VAT to invoices that should be reverse charged. What matters is the nature of the supply, not what is on the invoice.
If an invoice includes VAT but the supply should be reverse charged, the customer must:
- Ask the supplier for a corrected zero-rated invoice
- Account for the reverse charge VAT appropriately
- Only recover the input tax, not any VAT shown on the invoice
This ensures the VAT is correctly reverse charged and avoids potential disputes with HMRC.
Can you reverse charge VAT on imports?
For goods imported from outside the EU, VAT is charged by HMRC at the point of importation rather than by the supplier. So normal VAT rules apply rather than a reverse charge.
Import VAT is levied on the total value of goods imported, including any duties, insurance, transport and other costs. Payment of import VAT must be made to HMRC before the goods are released.
The import VAT can be reclaimed by VAT registered businesses on their next VAT return, subject to normal input tax recovery rules. So import VAT does not create any additional VAT cost for businesses.
Summary
In summary, the main takeaways about VAT reverse charges are:
- It shifts responsibility for VAT from supplier to customer
- Applies on services from non-EU suppliers
- Also used in the construction sector for subcontractors
- Customer accounts for VAT instead of the supplier
- Registered businesses can reclaim reverse charge VAT
- Unregistered firms face a real VAT cost
- Important to check if a reverse charge applies
- Well managed reverse charges need not create problems
Reverse charging VAT may seem complicated but is important to manage properly. Do discuss with your accountant if you are unsure how to account for VAT on any supplies made to or from your business.
Frequently Asked Questions
What is VAT reverse charge?
A VAT reverse charge means the customer, rather than the supplier, accounts for and pays the VAT due on a purchase. The responsibility for VAT shifts from the supplier to the customer.
When does reverse charge VAT apply?
The main situations are services from non-EU suppliers and certain construction services between UK businesses. The aim is to ensure VAT is properly collected where normal VAT rules would not work.
How do you account for reverse charge VAT?
The supplier issues a VAT-free invoice. The customer then accounts for VAT as output tax and input tax simultaneously on their VAT return. So no money is actually paid to HMRC until the return is filed.
Can you reclaim reverse charge VAT?
Yes, if the customer is VAT registered they can recover reverse charge VAT as input tax in the normal way. The VAT reverse charge does not create any additional VAT cost for VAT registered businesses.
What if VAT is incorrectly charged?
If a supplier mistakenly includes VAT on a reverse charge invoice, the customer should ask them to issue a corrected zero-rated invoice. The VAT is still correctly reverse charged based on the nature of the supply.
Can you choose to reverse charge UK suppliers?
No, only the specified reverse charge situations defined in law apply. UK VAT registered businesses cannot voluntarily reverse charge other UK suppliers as this would breach VAT rules.
Conclusion
Applying VAT reverse charges correctly is important for both suppliers and business customers. All businesses involved should understand when a reverse charge applies and the procedures required.
Some professional advice may be needed when setting up accounting systems and software to handle reverse charges. Training staff is also key to ensure reverse charge invoices and VAT returns are processed properly.
Provided reverse charges are managed well, they do not normally create difficulties or additional costs for VAT registered businesses. But errors or failure to operate reverse charges could lead to problems and penalties from HMRC.