Understanding the VAT Reverse Charge: A Simplified Guide
Dealing with VAT can be a challenge for any business, whether it’s figuring out when to register once you hit the income threshold or adjusting your prices to include VAT. But what about VAT on purchases made from businesses based overseas? That’s where the VAT reverse charge comes into play.
If you’re not VAT-registered, good news – the reverse charge doesn’t apply to you, so you can skip the stress! However, if your business is VAT-registered and you purchase goods or services from suppliers outside the UK, this guide is for you. Let’s break down what the reverse charge means and how it affects your business.
What Is VAT?
VAT, or Value Added Tax, is a type of tax that’s typically added to most goods and services sold by businesses registered for VAT. While some businesses choose to register voluntarily, it becomes mandatory once your taxable turnover exceeds £90,000 in a 12-month period.
There are exceptions, of course. For example, if your business only deals in VAT-exempt goods or services, you wouldn’t need to register.
How Does VAT Work?
If your business is VAT-registered, you’ll need to charge VAT on most of your sales, depending on the applicable rate for your products or services (the standard rate is 20%). It’s crucial to keep accurate records of the VAT you’ve charged customers, as well as the VAT you’ve paid on your business purchases.
After completing your VAT return, HMRC will determine whether you’re owed a VAT refund or if you need to pay the difference. You’ll receive a refund if you’ve paid more VAT on your purchases than you’ve charged to customers. On the other hand, if you’ve collected more VAT from your sales than you’ve paid out, you’ll owe the difference to HMRC.
Using bookkeeping software can make this process easier by allowing you to store all your VAT invoices and records digitally and submit your returns directly to HMRC.
What Is the VAT Reverse Charge?
In simple terms, the VAT reverse charge is the VAT that you would normally pay on goods or services if you had purchased them from a UK supplier. However, in the case of the reverse charge, the responsibility of accounting for VAT shifts from the seller to the buyer, meaning you, the customer, need to account for the VAT instead of the supplier.
This also means that the overseas seller doesn’t have to register for VAT in the UK, even though they’re supplying goods or services here.
How Does the VAT Reverse Charge Work?
Imagine you hire a graphic designer based in Germany to create a logo for your business, and the cost is €500. The designer won’t add VAT to the invoice, but they will note that the reverse charge applies.
You’ll then account for this on your VAT return as if you were dealing with a UK-based supplier. If the standard VAT rate is 20%, you’d calculate 20% of €500, which is €100. After converting this amount into pounds, you include it as both the VAT you’ve paid and the VAT you’ve charged, effectively canceling out the VAT within the same return.
How Do I Handle Different Currencies in the VAT Reverse Charge?
If you receive an invoice in a foreign currency, you can’t directly apply the UK VAT rate. First, you need to convert the invoice amount into British pounds using the exchange rate on the date the invoice was issued. Once converted, you can then apply the VAT reverse charge accordingly.
How Do I Report the VAT Reverse Charge on My VAT Return?
You’ll need to record the VAT reverse charge in two places on your VAT return:
- Total VAT Paid: Include the reverse charge in the total VAT your business paid during the period.
- Total VAT Charged: Report the reverse charge in the total VAT your business charged during the same period.
By doing this, you cancel out the VAT charge within the same return, avoiding the need to reclaim it in a future period. If you’re unsure about any part of this process, it’s always a good idea to consult with your accountant.
What If I Sell to a Business Outside the UK?
If you’re the seller, the process is similar, but in reverse. You won’t add VAT to your invoice, but you must include a note indicating that the VAT reverse charge applies. The buyer, who is outside the UK, will then be responsible for calculating and reporting the VAT on their end.
Ensure that your invoice clearly outlines the services provided, where they are supplied, and the reason for not charging VAT.
Is the VAT Reverse Charge the Same as the VAT Domestic Reverse Charge?
No, they are different, although both operate on similar principles. The VAT domestic reverse charge is specific to the construction industry within the UK. It helps combat VAT fraud by shifting the responsibility for accounting for VAT from the supplier to the customer, typically the contractor. This means that contractors must account for VAT on the services they purchase and include it in their VAT returns.
