This article highlights an area of VAT law that organisations regularly misunderstand and which can lead to VAT compliance failings, costing time and money to resolve.
The reverse charge applies to most services received from overseas suppliers (there are some exceptions such as services directly related to land overseas). Essentially, if a UK based VAT registered organisation receives a relevant service from a supplier based outside the UK, it must account for VAT under the reverse charge mechanism.
The reverse charge requires the UK organisation to charge itself VAT at the standard rate on the UK VAT return. This is included as output tax in box 1 of the VAT return. This VAT can then be recovered as input tax in box 4 of the VAT return, subject to the usual rules on VAT recovery. It is essentially an anti-distortion of competition measure to protect UK suppliers who would be charging 20% UK VAT on their services; by requiring the customer to self-account for UK VAT when purchasing services from overseas suppliers, it ensures a level playing field.
The value of services received from overseas must be included as taxable turnover when considering the VAT registration threshold of £85,000.
Where the UK organisation is fully taxable, i.e. it only makes taxable supplies, the reverse charge mechanism essentially has a nil net effect. The VAT It is included in box 1 as output tax and recovered in box 4 as input tax.
Where the organisation is partially exempt, there will be a VAT cost to the reverse charge mechanism, as usually the full amount cannot be recovered in box 4. Therefore, where the organisation fails to account for the reverse charge, HMRC will charge an assessment for the omitted VAT. HMRC may also seek to charge a penalty.
For non-VAT registered organisations, the value of services received from overseas may require the organisation to become VAT registered, as the net value of these supplies is included as taxable turnover. This may mean that the organisation is required to register for VAT historically, depending on the value of services received from overseas. Where an organisation fails to notify HMRC of its requirement to be VAT registered, HMRC may seek to charge a penalty.
VAT registered organisations should ensure that systems are in place to identify services received from overseas that are subject to the UK reverse charge rules. This will ensure that the correct amount of VAT is remitted to HMRC on these services.
Non-VAT registered organisations should monitor the levels of services received from overseas, alongside their other income streams to ensure that they are operating beneath the threshold. Should these organisations breach the current VAT registration threshold of £85,000, they will need to notify HMRC within 30 days.
The reverse charge mechanism is an area of VAT that is frequently reviewed as part of HMRC’s routine inspections for organisations. Should you be interested in some of the other common issues we have seen, please see our recent article on this here.
Should you wish for further advice on this topic, please contact Robert Marchant, or your usual Crowe contact.
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