What do reverse charges have to do with VAT?

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I have a client who manufactures and instals greenhouses internationally and have already written an article based on a conversation with Rhys, the company’s owner, about how to determine when to apply VAT to import and exports.

When I next visited, Rhys said that he’s taken on some VAT registered subcontractors, who are in the construction industry scheme, so their work is subject to reverse charges.  He pointed out that I’d told him that reverse charges apply to importing services so was confused about how the two were related.  So we put the kettle on again and went through it!

What is a reverse charge?

It is when the responsibility of applying and accounting for VAT sits solely with the customer.  Under normal circumstances a VAT registered supplier, charges output tax on their sales, and their customers, as long as they are VAT registered, reclaim the VAT as input tax on their purchases.  However, when a reverse charge applies the supplier does not charge output tax and the customer accounts for both the input and output tax simultaneously.

When reverse charges are used

There are a number of circumstances in which reverse charges are used:

  • Importing goods
    • Postponed accounting, is in effect a reverse charge, as it accounts for the value of the VAT due on imported goods and the amount to be reclaimed at the same time.
  • Importing services
  • Buying and selling some goods and services HMRC has specified as being subject to the ‘domestic reverse charge’.
    • These are mainly to do with the telecommunications, gas and electricity and construction industries.
  • Buying and selling services under the construction industry scheme (CIS)

Why reverse charges are used

There are a number of reasons why reverse charges are used.  In the case of postponed accounting, it is to help ease the impact of import tax on an organisation’s cash flow.  However, with regard to the construction industry and the CIS scheme, it is an anti-fraud measure, designed to ensure that VAT is properly accounted for.

How is VAT accounted for when a reverse charge is applicable?

Well, it is included in Box 1 of the VAT return as output tax due and Box 4 of the same return, as input tax reclaimable.  That way no money actually changes hands and the overall net VAT position is unchanged from the customer’s point of view, but the VAT is accounted for as far as HMRC is concerned.

The net amounts will be included in Box 6, with regard to the output, in other words the sale, and the net value of the input, or purchase, will be included in Box 7.

Note that when postponed accounting is used, the net value of imports is included in Box 7, but there is nothing to include in Box 6.

How does reverse charging affect invoicing?

Suppliers of goods and services subject to a reverse charge, like subcontractors who are in the CIS, should not include VAT on their invoices.  However, they should:

  • include all the other information normally required on a valid VAT invoice
  • include a statement that makes it clear that reverse charges are applicable and that it is the customer’s responsibility to account for the VAT
  • clearly state how much VAT is due under the reverse charge, or the rate of VAT if the VAT amount cannot be shown, but the VAT should not be included in the amount charged to the customer.

The VAT regulations 1995 say invoices for services subject to the reverse charge must include the reference ‘reverse charge’ and HMRC provides examples of wording on its website that meet the legal requirement.

Note that the above does not apply to invoices for imported goods and services, as they will not be subject to UK rules but rather those that apply in the country the business is in that is supplying the goods

Further reading:

Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.

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