Reverse Charge VAT in 2023

Reverse charge VAT is something of a maze. It takes the basic concept of VAT, where you charge VAT and then pay that amount to HMRC, but it removes the middleman. Instead of paying the VAT to you, your customer pays the money directly to HMRC.

Yes, it’s easy to understand why most people get confused. Why would the customer suddenly be paying VAT?

The answer lies in the need to mitigate fraud. Some suppliers charge VAT on their invoices but end up keeping the money for themselves, not paying it to the tax authority. Domestic reverse charge VAT was implemented in the UK to prevent this fraud by expecting the customer, or end user, to take on the responsibility of paying VAT. 

The other type of reverse charge VAT lies in cross-border VAT charges that apply to companies that purchase services outside the UK.

For example: Bob is a handyman, and he comes in to fix the gutters at an office block. He then charges the company his fee plus VAT. With reverse charge VAT, he would only invoice for his services, noting on his invoice that he is abiding by VAT reverse charge rules, and the company then pays the VAT to HMRC directly.

Note: The sector most affected by reverse charge VAT is the construction sector.

What are the implications of Reverse Charge VAT?

If you want to know exactly how reverse charge VAT may affect your business or industry, visit the HMRC website here, or follow the detailed guidance notes on the domestic reverse charge procedure here.

Impact on Business

If your business qualifies for reverse charge VAT, then it can affect your income and cash flow. Cash that would have sat in your business is now paid directly to HMRC, so it is no longer available to you. You may also find that you will have to set aside cash to manage supplier payments and to keep as working capital because the drop in VAT payments will affect your available cash supplies.

Effect on Cash Flow and Accounting

As outlined above, your cash flow may be directly affected by reverse charge VAT as suddenly 20% that came in with every invoice is no longer coming into your business and instead is being sent directly to HMRC. As cash flow can really make or break a business, it is critical that you plan ahead.

It is a good idea to work with your accountant or accounting team, as well as with trusted accounting service providers, to restructure your finances and cash flow expectations to match this shift in income. If you can plan ahead properly, then you can minimise the impact on your bottom line.

Country-Specific VAT Regulations in the EU

As mentioned above, each country in the EU has different VAT compliance requirements so you would need to understand the nuances of the countries you deal with individually to ensure you remain compliant. The list below, which is not exhaustive, outlines some of the VAT requirements across the major EU economies of France, Germany and Italy.

France: Applying for VAT is mandatory in France before you start doing business in the region. Your company will have to apply for VAT and submit a VAT return every month if your turnover is more than 818,00 Euros for sales and accommodation activities, or more than 247,000 Euros for service activities.

Germany:  As a foreign company, you have to be on top of your VAT requirements from the outset because the country imposes harsh fines on companies that don’t complete their forms on time or who don’t complete their VAT registration before they cross the threshold. You have to apply for VAT using their online portal and will be given a unique VAT identification number and general tax number.

Italy: Your VAT registration gives you an 11-digit code that will be used on all your documentation throughout your time dealing with the state. If you are a non-resident you can appoint a tax representative who is based in Italy and has an Italian VAT number or you can register directly with the country – but the latter is only available to countries within the EU or who have a trade agreement with Italy. You will need to register with the Italian Revenue Agency and provide specific information as required by the authority to ensure your registration is compliant.

Reverse Charge VAT Mechanism

Reverse charge VAT primarily impacts the building and construction industry across certain services and materials used to provide these services. These are some of the scenarios that are affected by reverse charge VAT as taken from the HMRC website:

• Painting and decorating on buildings and structures
• Constructing, altering, repairing, extending, demolishing
• Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply, or fire protection systems
• Internal cleaning of buildings and structures
• Services that form part of the preparation or completion of services

How does the EU’s Reverse Charge Mechanism Work?

So, now you know how reverse charge VAT works, you want to know how this applies in the EU context. You need to pay the VAT for your transactions directly to the relevant tax authority. The rules around this form of reverse charge VAT is outlined in section 226 of the EU VAT Directive and must be followed to ensure you’re eligible and compliant.

The use of reverse charge VAT in the EU was introduced to mitigate fraud and reduce the compliance burden, but that said, you still need to understand how it works before you start.

EU Reverse Charge VAT in Practice

For example: If you are a supplier, you would include VAT on your invoice for your customer and then submit the VAT to the relevant tax authority because this is your responsibility. Now, if you are providing these services across borders and the reverse charge VAT rule is in place, then the responsibility of submitting the VAT moves from you, the supplier, to your customer. If your transaction takes place in France and you purchase goods from someone in Latvia, then the place of supply is France and French VAT rules apply. The business partner in Latvia would then submit an invoice without VAT included but with clear notifications that reverse charge VAT is in place and then the customer, you, will have to pay the VAT to the French tax authority.

Compliance and Legal Requirements

If you want to know more about how this works and you are in the supply building and construction industry go here, or if you are in the buy building and construction industry services go here. There is also an extensive list of different types of suppliers and how you can opt into becoming an end-user (the company paying the VAT to HMRC) on the tax authority’s website.

Registration and Eligibility

After reading through the extensive HMRC documentation above, you should now know if you are eligible for reverse charge VAT. This means you will not charge VAT on your invoices, and the responsibility for paying VAT falls to your customer – you just need to ensure you mark this on your invoices going forward.

Document and Record-Keeping

If you are eligible for reverse charge VAT, you need to have accounting systems capable of handling the requirements it entails. This will help you manage your cash flow (which is an important part of reverse charge VAT) and ensure that you remain compliant with HMRC.  

Reporting and Filing Obligations

When you complete your VAT returns, you will include the VAT exclusive value of the services you supplied in the total value of the sales you made. You will not have to fill in output tax because that has become your customer’s responsibility.

Reverse Charge VAT Best Practices

Internal Processes and Systems

It is important that you use a trusted accounting platform and service provider to ensure that your cash flow is not adversely affected by your use of reverse charge VAT. Your accounting team should also be aware of the requirements around completing your VAT return with reverse charge VAT rules in place, and you should have all the paperwork you need to provide proof of your having invoiced with reverse charge VAT accounted for.

Supplier and Customer Communication

If you are eligible to pay reverse charge VAT, then it is worth contacting your suppliers and customers to let them know that the onus of paying VAT falls on them. This will help them to put their processes in place to ensure that their cash flow is not affected and that they remain compliant with the tax authority.

The Sectoral Impact of Reverse Charge VAT in the EU

Reverse charge VAT applies to EU transactions that include:

• Business-to-business transactions between companies in EU member states. 
• Providing services to a business VAT registered within the EU where the place of supply is where the service takes place.
• The different sectors that apply to reverse charge VAT tend to differ from country to country. So, for example, in Germany it applies to installation goods and services.

FAQs on Reverse Charge VAT

Have you still got burning questions about reverse charge VAT? We answer some of the main ones for you below:

Who is Responsible for Reporting and Paying Reverse Charge VAT?

You are responsible for letting your customers know that you are now eligible for, and invoicing for, reverse charge VAT. They are then responsible for reporting the VAT and paying it to HMRC.

Are there any exceptions or specific transactions exempt from Reverse Charge VAT?

Certain goods and services are excluded from reverse charge VAT, such as supplies to businesses that are not registered for VAT, supplies to customers that are not using them for the business, and cross-border transactions of certain goods and services. For a complete list of exemptions, read the HMRC technical guidance here.   

What documentation and invoicing requirements are necessary to comply with Reverse Charge VAT?

As a reverse charge VAT supplier, you need to ensure that you note that your invoice has reversed the VAT charge to your customer.

Can businesses reclaim Input VAT under Reverse Charge VAT?

You can reclaim your Input VAT on your reverse charge purchases in your VAT return.

How does Reverse Charge VAT affect cross-border transactions within the European Union (EU)?

This is an in-depth topic, as cross-border reverse charge VAT has its own regulations and expectations. However, if you would like to know more about cross-border VAT, you can read the VAT on Services from Abroad guidelines here.

Are there any thresholds or turnover limits for Reverse Charge VAT application?

As Reverse Charge VAT applies to business-to-business transactions, this means that the VAT paid and the VAT thresholds are determined by the VAT rules in the country of the customer. This means that the thresholds or turnover limits that affect this charge will be dictated by the country within which you do business.

Blue dot’s Insights and Recommendations

Reverse charge VAT can sound complex, but with the right support and technology, you can easily manage its implications for your business. If you would like a bit more information about VAT, we have developed a series of Tax Education videos designed to make your life easier. As the world’s leading tax compliance platforms, our AI-driven technology provides incredible insights and support to help you make the most of your VAT opportunity across all entities and regions while ensuring compliance.

Our online VAT Reclaim Calculator can help you calculate your VAT in employee spend and remain compliant with global tax regulations while maximising your VAT reclaim.