Reverse-charge VAT rule is flipping confusingby
Reverse charge is one of those VAT rules that not everyone understands. To add to the confusion, there is more than one application of reverse charge and some of those applications have different rules.
Reverse charge is a catch-all phrase that acts as either an anti-avoidance measure or a simplification. Its purpose is to flip normal VAT rules on their head and shift the liability for VAT onto the customer, with the seller not accounting for VAT.
This flipping of the rules is perhaps why some struggle with reverse charge, and it comes in many flavours.
1. Reverse charge relating to services – sales-to-business customers
When making a sale of services to a business-to-business customer that falls under the default rules (for example, not land-related, not a live event, and not falling under the use and enjoyment rules), the place of supply is where the customer is and the supplier does not charge VAT (outside the scope of VAT) and the customer accounts for VAT at their end. The sale is still recorded in Box 6 (net), with no output tax due in Box 1.
The above applies whether the customer is in the EU or the rest of the world. If the customer resides in a country where VAT does not exist (such as the USA), then the customer has nothing else to do. If the customer resides in a VAT-operational country, they will either reverse charge on their VAT return or they will treat the purchase as counting towards the VAT registration threshold in their own country.
2. Reverse charge relating to services – purchases from suppliers
When a UK business is receiving a service from overseas, if VAT-registered, the business takes the net figure on the invoice and treats it as both a sale and a purchase, the net figure going into Boxes 6 and 7.
For output tax, the business calculates the VAT on the net value as appropriate (5/20%) and declares output tax in Box 1. In effect, a sale to itself. With regard to input tax, ordinarily the figure calculated on the net purchase that is declared in Box 1 is also declared in Box 4 (if) the business is able to fully recover its input tax (fully taxable business).
Don’t forget partial exemption. If the business is partially exempt, it still declares output tax in Box 1 but the input tax in Box 4 is reclaimed based on the partial exemption percentage operated by the business. Therefore Box 4 may see the input tax recovered match the output tax declared (VAT neutral) or the input tax could be less than that declared in Box 1 and effectively an element of input tax is irrecoverable, depending on the partial exemption calculation.
If the business is a charity with donation and grant income, then they may also need to further restrict input tax in Box 4 under business/non-business apportionments.
Don’t forget the reverse-charge trap. If the business is not VAT-registered, any purchases of services from overseas would count towards the UK VAT registration threshold because we treat the purchase as a sale (to ourselves) then it counts towards the VAT-registration threshold.
It is therefore possible for a fully exempt business to trigger a requirement to register for VAT if it purchases more than £85,000 of services from outside of the UK. It’s quite a large threshold and so for many businesses it will not be an issue, but where a business buys in lots of overseas services (Google, PayPal, web design and so on) it should ensure it includes these purchases as turnover for the monthly VAT registration threshold test.
3. Flat-rate scheme
The sale of services to a non-UK person, assuming the default rules are in play, is outside the scope of VAT. It is worth noting that for the flat-rate scheme, we do not include outside the scope of VAT sales when it comes to calculating output tax under the flat-rate percentage.
On the purchasing side, one would declare output tax in Box 1 and also in Box 4. The business is seen as fully taxable in this scenario and therefore Boxes 1 and 4 are VAT neutral. Even if the business is partially exempt, there is no requirement to apportion the reverse charge input tax in Box 4. A partially exempt business would still include exempt sales within the flat-rate turnover and declare output tax on those exempt sales using whatever their flat rate percentage is.
4. Domestic reverse charge for construction services (DRC)
The word “domestic” in front of “reverse charge” is meant to indicate that reverse charge applies on domestic (UK to UK) transactions, whereas normally reverse charge is about cross-border transactions.
Rickie Lowery’s earlier article covers the technical points of when domestic reverse charge is or is not applicable. The key to DRC is to first understand the Construction Industry Scheme (CIS) because it is that scheme that drives the rest of the decision-making.
Assuming the conditions for DRC have been met then making a sale under DRC the net invoice goes to Box 6 (as it is a sale) only, the output tax is zero-rated/nil for Box 1. The invoice must state that the services are subject to DRC and should also show the VAT rate and the VAT that the customer must reverse charge on their VAT return.
Where a business is receiving a DRC supply, then the net goes to Box 7 and the corresponding VAT (as per shown on the invoice) goes into Boxes 1 and 4, with the assumption the business is fully recoverable. If it is not, then Box 4 would reflect the partial exemption position of the business receiving the supply.
This article aims to give a clear explanation as to the various nuances between the reverse charge rules and also clarity as to which value goes into which box on the VAT return.
There are some scenarios where reverse charge applies in relation to construction services/land-related supplies when supplied by an overseas supplier and we will cover that in a future article.
More on reverse charge and VAT rules is available here.
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Jason has over 20 years’ experience working exclusively in indirect taxes (VAT, import duty, SDLT) with owner-managed businesses, corporates and not for profit sectors. He particularly enjoys challenging HMRC decisions, representing clients in tribunals or during inspections.
Experience includes land and property, partial exemption and...