VAT Through the Looking Glass
An unexpected consequence of going global?
If your business is procuring goods or services from abroad or buying certain types of specialist goods domestically, think “mirror, mirror on the wall…”
There is a concept in international law called renvoi which literally means “send back” and is about choosing which legal system (i.e. jurisdiction) should apply. The reverse charge in VAT is a bit like that, where everything is turned on its head and sent back as a mirror image so that the burden of taxation falls not on the person making the supply but the person receiving the supply (i.e. as a tax shift).
Like many things in VAT management, this is counterintuitive. VAT should be accounted for where the supply takes place (or is deemed to take place), as determined by the place of supply rules. But this does not mean where the supply is made, it means where the supply is received. VAT is a tax on the consumer and therefore it should be taxed in the jurisdiction where the supply is consumed. The reverse charge means that the recipient of the supply both charges the output tax (to themselves) and claims the input tax. Logical when you think about, but also very confusing if you do not understand why this should be the case.
And it is not all about services. A form of reverse charge applies to movements of goods between Member States in the EU although it is called acquisition tax. But the principle is the same, the recipient accounts for the tax in the Member State of acquisition and also claims the input tax. A reverse charge on certain goods such as mobile phones and computer chips, or wholesale gas and electricity is also used as an anti-fraud measure (for example, for missing trader intra-community fraud in the EU).
This can cause problems for suppliers and purchasers alike. Whether to charge the VAT or not? And if you are not charged VAT how to deal with it? Unfortunately, businesses often get it wrong. A particular risk is where goods are chargeable at one rate in one Member State but chargeable at another rate in another Member State. Businesses often do not know the rules in other Member States. An example of this would be books or children’s clothing moving between the UK and another Member State. In the UK books and children’s clothing are zero-rated but in other Member States they can either be reduced-rated or standard-rated. It is often the case that the VAT liability differs between the Member State of removal and the Member State of acquisition. The rule, of course, is that VAT is due at the rate in force in the Member State of acquisition, but that is not always obvious.
Or the business may claim the input tax and forget to account for the output tax. Or calculate the output tax correctly and forget to claim the input tax. This can either arise through weaknesses in accounting systems, controls or the division of responsibilities between debtors and creditors. In other words, when the right hand does not know what the left is doing, a common scenario in VAT. And a recent study has shown that 80% of corporates still rely on spreadsheets to align international VAT transactions. Non-aligned accounting systems means manual intervention and manual intervention means human error (especially when the intervention is non-specialist as it often is). This can make filling out a tax return in Europe incredibly confusing and inaccurate. If something can go wrong it will go wrong at some point.
This can happen in any area of tax but the reverse charge is a blind spot. Not being charged VAT causes confusion. For example, the reverse charge applies to any services received from outside an EU Member State. Within the EU it is sometimes assumed that because the reverse charge is an EU provision it only applies to services received from other Member States and not to supplies from outside the EU. But this is not the case. The reverse charge is a balancing provision to place businesses in the same position as they would be in if purchasing the services (or goods in certain circumstances) in their own Member States, whether or not from elsewhere within the EU or outside.
Confused? You are not alone!
Finally, stringent levels of documentary evidence are required for the reverse charge supplies of goods. For example, for removals within the EU the supplier must ensure that the recipient is in business and obtain their VAT registration number. They must also keep evidence that the goods have been transported from the relevant Member State. then it can be difficult to get the evidence required.
So, if your business is procuring goods or services from abroad or buying certain types of specialist goods domestically, think “mirror, mirror on the wall…” because the VAT bounces back on you!
Martin Kaney
Director, X-VAT
