What is reverse charge VAT?
Reverse charge VAT is a special VAT accounting mechanism used typically in business to business transactions. It reverses the responsibility for accounting for and paying over VAT to HMRC from the supplier to the customer. This avoids the need for the supplier to register for VAT in the UK if they are not already VAT registered.
The reverse charge applies to specified services where there is a high risk of VAT fraud by missing trader intra-community fraud. Under the reverse charge, the customer accounts for the VAT instead of the supplier.
How does reverse charge VAT work?
Normally with VAT, the supplier charges VAT on their sales invoice and accounts for it to HMRC. The customer claims back the input VAT, subject to normal VAT rules.
With reverse charge, the supplier issues a VAT invoice indicating the supplies are subject to reverse charge, without VAT added. The supplier does not account for output VAT to HMRC.
The customer then accounts for the VAT to HMRC as output tax on the same return in which they claim it back as input tax, subject to normal VAT recovery rules. So no net VAT is paid to HMRC, but the transaction is correctly accounted for.
This avoids the supplier needing to register for UK VAT. It means UK VAT compliant businesses do not miss out on input tax recovery on reverse charge purchases.
When does reverse charge VAT apply?
The main situations where reverse charge VAT applies are:
- Services connected to land, such as construction, demolition, site preparation, legal services relating to land transactions
- Some commodity trades in wholesale energy markets
- Trades in emissions allowances covered by the UK Emissions Trading Scheme
- Mobile phones, computer chips, game consoles, tablet PCs
- Gas and electricity traded through a wholesaler
- Supplies of metals including gold, silver, palladium
- Supplies of Investment Gold
There are detailed rules on precisely which supplies qualify. The reverse charge applies where both parties are business registered for VAT in the UK, or where the supplier is abroad. There are some exceptions where the supplier is still required to charge and account for VAT as normal.
Do you pay VAT on reverse charge?
Strictly speaking, the customer does not actually pay any VAT to the supplier on reverse charge supplies. No VAT is included on the sales invoice.
However, the customer does account for VAT to HMRC on their VAT return, at the same time as recovering the same amount of input tax.
So while no money changes hands, reverse charge transactions are still subject to the accounting procedures of the VAT system. The supplier declares their sales as reverse charge. The customer accounts for VAT in the normal way, even though they do not physically pay it over to the supplier.
Reverse charge VAT procedures
The procedures for the supplier and customer in a reverse charge transaction are as follows:
Supplier:
- Issue a normal VAT invoice to the customer, stating that reverse charge applies
- Do not charge or account for output VAT to HMRC
- Treat the sale as outside the scope of VAT on their VAT return
Customer:
- Do not pay VAT to the supplier
- Account for VAT on the transaction as output tax to HMRC
- Recover the same amount of VAT on the purchase as input tax
- Net effect is no VAT payment to HMRC
So while no VAT is physically paid on reverse charge transactions, the correct amount of VAT is declared and accounted for. This ensures the Exchequer does not lose out.
Why does reverse charge exist?
Reverse charge VAT exists for two main reasons:
1. Preventing VAT fraud
Missing trader or carousel fraud exploits the time lag between companies charging and declaring VAT to HMRC. Fraudsters charge VAT to customers, then disappear without paying it to HMRC. Reverse charge removes this opportunity by shifting responsibility to compliant businesses.
2. Easing compliance for suppliers
Suppliers can make B2B sales to UK customers without needing to register for VAT here. The administrative burden falls on the customer instead.
Reverse charge means overseas businesses can easily supply B2B services to UK firms without setting up a UK VAT registration because their customer accounts for the VAT.
This reduces compliance costs and administration for suppliers. But customers take on more responsibility for each reverse charge purchase.
Examples of reverse charge VAT
Here are some examples of how reverse charge VAT works on typical transactions:
1. Construction services
Builder A supplies construction services to Business B for £120,000 plus VAT. Under normal VAT rules, Builder A would:
- Charge Business B £144,000 (£120,000 + £24,000 VAT)
- Pay £24,000 output VAT to HMRC
Business B would:
- Pay £144,000 to Builder A
- Reclaim £24,000 input VAT from HMRC
But because construction is a reverse charge supply, the VAT transaction is as follows:
Builder A:
- Charges Business B £120,000 (excl VAT)
- Puts sales through as outside scope on VAT return, so no output VAT to declare
Business B:
- Pays £120,000 to Builder A
- Accounts for £24,000 output VAT to HMRC
- Claims £24,000 input VAT from HMRC
2. Imported mobile phones
Phones Ltd, based in China, sells a batch of mobile phones to UK wholesaler Brit Phones for £50,000. Standard rate VAT applies to imported mobile phones.
Under normal rules, Phones Ltd would register for UK VAT and:
- Charge Brit Phones VAT of £10,000 on the £50,000 sale
- Account for £10,000 output VAT to HMRC
Brit Phones would:
- Pay £60,000 to Phones Ltd including VAT
- Reclaim £10,000 input VAT from HMRC
But under reverse charge:
Phones Ltd:
- Charges £50,000 to Brit Phones (excl VAT)
- No need to register for UK VAT
- No output VAT to declare to HMRC
Brit Phones:
- Pays £50,000 to Phones Ltd
- Accounts for £10,000 output VAT to HMRC
- Reclaims £10,000 input VAT from HMRC
So Brit Phones accounts for the import VAT rather than Phones Ltd having to register in the UK.
Pros and cons of reverse charge VAT
Reverse charge VAT has advantages and disadvantages, both for suppliers and customers:
Advantages
For suppliers:
- No need to register for VAT in customer’s country
- Lower compliance obligations and administration
- Cashflow benefit from not paying output VAT to tax authority
For customers:
- Built-in method to account for VAT properly
- No cashflow disadvantage as input VAT reclaimed
- Prevents dodgy suppliers taking the VAT and disappearing
For tax authorities:
- Gets VAT from trusted source (the customer)
- Limits fraud by removing scope for missing trader scams
Disadvantages
For suppliers:
- Extra work producing compliant reverse charge invoices
For customers:
- Extra administration handling reverse charge accounting
- Need systems to deal with it correctly
For tax authorities:
- VAT accounting reliance moves to customers
- Suppliers’ VAT compliance is then less scrutinised
So reverse charge does shift obligations from supplier to customer. This can increase risks of incorrect VAT accounting by customers. But the overall VAT result is the same.
Conclusion
While no VAT is physically paid to the supplier, reverse charge means the customer must still account for it to HMRC. So transactions are still within the VAT system.
Reverse charge exists primarily to combat missing trader fraud. It places VAT accounting obligations on the domestic customer rather than overseas supplier.
This simplifies compliance for suppliers but adds administration for customers. Tax authorities still get the VAT revenue, just from a different source.
So while the customer does not pay VAT to the supplier, reverse charge transactions still incur and account for the appropriate amount of VAT.