We clarify the reverse charge rules and highlight some points you may need to be aware of when processing payments.

The reverse charge is a fairly simple concept: where a business buys a service from outside the UK, and the service would have been subject to VAT if supplied by another UK business, the buyer has to account for VAT. If this were not the case, the tax would be too easy to avoid. In the financial sector, where many businesses can recover little or none of the VAT they incur, this can be a significant cost – especially when they get it wrong. Here are some pointers that might help keep you out of trouble.

  • Technically, the reverse charge is deemed to be a supply of services both by and to the recipient. The buyer therefore has to account for output VAT and then apply the partial exemption rules to calculate how much can be recovered as input VAT. One dangerous side-effect of this mechanism is that the notional supply by the purchaser counts as taxable turnover, which can take the business over the VAT registration threshold even if all of its day-to-day business activities are VAT-exempt.
  • The reverse charge now applies to virtually all services supplied from overseas, but not if they would have qualified for exemption within the UK. So if the supplier is another financial sector business, it may be worth looking behind the invoice and making sure that you have a full description of their work.
  • Bear in mind that the VAT definition of a service encompasses any transaction that is not a supply of goods. The reverse charge therefore applies to various forms of intangible rights, intellectual property, software licences and similar costs as well as the more obvious services such as advice.
  • Charges from associated companies are often overlooked. Supplies of staff, IT support services, and head office 'management charges' are all liable to the reverse charge even if no invoice is issued and – potentially – even if no payment is made.
  • At present, UK law disregards services supplied by companies within a VAT group registration, but even this is at risk. The European Commission takes the view that a VAT group is a separate taxable person from any of its member companies, and thus that supplies from overseas branches of group members are taxable. The UK (along with another seven member states) now faces infraction proceedings at the European Court of Justice. If the Court agrees with the Commission that our grouping rules are too generous, these services will also come within the scope of the reverse charge.

With the VAT rate about to go up, and heavy penalties for businesses that fail to take 'reasonable care', this is a good time to check that your business is handling the reverse charge correctly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.