If your company does business internationally, particularly if you sell to other businesses (B2B sales), you probably need to understand the VAT (value-added tax) reverse charge mechanism, which is used in numerous countries that impose VAT, including the UK and all member states of the EU (European Union).
This mechanism changes the way that VAT is collected in certain transactions, shifting the responsibility from the supplier (or seller) to the buyer.
While the purpose of the reverse charge is to simplify VAT compliance and to combat VAT fraud, misunderstanding how it works can lead to costly mistakes that put your business at risk of audits and penalties.
This guide explains all you need to know about the VAT reverse charge mechanism, including when it may apply to transactions you're involved in, how to properly invoice customers in transactions when the reverse charge applies, and what you need to do in order to comply with your VAT obligations.
What is the reverse charge mechanism?
VAT is a consumption tax, and while the full VAT amount is ultimately passed on to the final consumer, businesses must collect the tax as value is added to a product at each stage of the supply chain.
Traditionally, suppliers must account for VAT due. This can become a substantial burden for companies involved in B2B sales in multiple countries, as they may become obligated to register to collect VAT in many different locations and to file VAT returns in every location where they meet registration thresholds.
When the reverse charge mechanism is employed, this obligation is reversed, making buyers responsible for reporting and paying the VAT.
The reverse charge mechanism can simplify tax administration by allowing foreign suppliers to avoid registration in some circumstances, and it reduces the likelihood of accidental noncompliance, because it shifts responsibility for payments to the buyer, who is more likely to understand local VAT laws.
How does the reverse charge mechanism work?
The reverse charge mechanism reverses the standard VAT collection process in certain B2B transactions.
Standard VAT process
Sellers charge VAT when selling goods or services. This is called "output" tax.
Sellers report the VAT collection to the local taxing authority and remit VAT payments.
Buyers pay the cost of the goods or services plus the VAT. This is called "input” tax. Buyers may be able to claim back the input tax and can credit it against VAT they charge.
Reverse charge process
Sellers do not charge VAT.
Sellers must note on the invoice that the reverse charge mechanism applies. Buyers pay the seller only for the cost of goods.
Buyers take responsibility for calculating the VAT on the transaction.
Buyers must report both the output tax and input tax on their VAT returns. If the output and input tax cancel each other out, no VAT is due.
Buyers who aren't registered for VAT or who are partly exempt may be required to account for VAT without being able to fully reclaim it.
The key feature of the reverse charge mechanism is that the responsibility for VAT collection is placed upon the buyer, not the supplier.
When does the reverse charge apply in the EU?
Whether the reverse charge applies will depend on the locations of the buyer and the seller, whether the transaction is a B2B or B2C (business to consumer) transaction, whether the supplier is VAT registered, whether the buyer is exempt, and the local VAT rules in the area where the place of supply is located.
The reverse charge mechanism may apply when:
- A supplier provides a good or service to a business in an EU member state where the supplier isn't established or registered, but where the buyer is required to register for VAT. The reverse charge mechanism has generally been mandatory under these circumstances within the EU since 2010 and is aimed at making sure the proper VAT is collected while simplifying the collection process by allowing some sellers to avoid registering for VAT.
- When a supplier provides certain B2B services (including telecommunications services, consulting, advertising, or intellectual property services) to a taxable entity, regardless of whether the transaction is a cross-border one. This domestic reverse charge mechanism applies in some EU countries to ensure that VAT is collected in industries where VAT fraud is a major risk.
- When certain construction services are provided in some EU member states, such as when subcontractors provide services to main contractors.
There are exceptions, for example, the supply of services directly connected to immovable property and live event admissions are taxed where the property is located or where the event takes place. The reverse charge mechanism for construction services also applies in some but not all member states.
How does the reverse charge mechanism apply in the UK?
When the UK left the EU, the country was free to establish its own rules.
The UK has put in place its own reverse charge mechanism rules, which are similar in many ways to the EU rules but differ in scope and application.
Like EU countries, the UK requires that the reverse charge mechanism be used for some services provided in the UK. However, as it is no longer a member state of the EU, the UK treats suppliers in EU member countries in the same way as it treats non-EU suppliers.
The UK also has established its own categories where the reverse charge mechanism applies as a method of ensuring compliance, including in transactions involving mobile phones, computer chips, and some construction services.
How to create a reverse VAT charge invoice
Reverse charge VAT invoices must meet specific requirements. For example, the invoice must make clear that the reverse charge mechanism applies.
The invoice should also contain the following:
- The seller’s name, address, and VAT number.
- The buyer's name, address, and VAT number.
- The issue date of the invoice and the date of supply (if different).
- A description of the goods or services.
- The net amount due for the goods and services.
- A reference to the reverse charge mechanism that complies with any applicable terminology requirements in the buyer’s country.
Failure to comply with these requirements can have serious consequences.
Benefits of the reverse charge mechanism
There are some significant benefits of the reverse charge mechanism, both for suppliers and for the governments that are reliant on VAT as a revenue source. Two of the biggest benefits are:
- Simplifying cross-border trade by potentially allowing suppliers to avoid having to register for VAT in all countries where they supply goods or services, and by allowing buyers to declare and reclaim VAT on the same return
- Reducing fraud, including "missing trader" or "carousel fraud," where scammers establish fake supply chains using shell companies, "sell" high-value goods across borders within the fake supply chain, and charge VAT but fail to remit payment to tax authorities
Final thoughts
While the reverse charge mechanism and other tax schemes, such as the EU’s One-Stop Shop, aim to make things simpler, tax compliance is a complicated subject, and the stakes are high, given the costs of an audit and penalties.
If you don't want to have to navigate the finer points of VAT on your own, or if VAT and sales tax compliance has become overwhelming or stressful, Numeral has you covered.
Numeral takes care of everything, including tracking transactions to determine when you must register for VAT, registering with the appropriate authorities, collecting the right amount of tax, and determining when the reverse charge VAT applies.
Numeral will even open mail from tax officials on your behalf. And Numeral can manage your tax compliance in more than 70 countries, so you can expand across the globe without giving more than a few minutes' thought to tax compliance issues.
