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Reverse charge pitfalls for partially exempt businesses

Nick Warner

The reverse charge VAT rules present a significant risk for partially exempt businesses, but the rules are often overlooked or misunderstood.

The reverse charge applies where a UK business buys in services from outside the UK. In such cases, the non-UK supplier will generally not charge any VAT. “But this does not mean that the UK business benefits from a VAT saving,” warns Robert Facer, a VAT expert with Moore. “The reverse charge rules require the UK business to charge itself UK VAT on the services it has purchased and declare that to HMRC as VAT payable on its VAT return. It can then treat the same amount of VAT as input VAT on purchases. So if the business is entitled to full VAT recovery, the reverse charge will be neutral – the VAT payable is the same as the VAT claimable.”

For partially exempt businesses that do not have full VAT recovery, the reverse charge creates a cost. The business has to pay 20% VAT on the services received, but will record somewhat less than that on the reclaimable part of the VAT return. “The reverse charge effectively puts the UK business in the same VAT position as if it had purchased the services from a UK VAT registered supplier, removing any distortion of competition” Robert says.

The reverse charge concept seems strange to many businesses, because it involves the customer accounting for VAT instead of the supplier. “For this reason, it is often misunderstood or overlooked,” Robert says. “For example, a point that is often misunderstood is that the reverse charge rules also apply to services received from within the same corporate group, such as management services supplied by an overseas parent company.”

Businesses should ensure that they have robust systems in place to ensure that reverse charge VAT is accounted for accurately. HMRC can impose significant penalties and interest charges where mistakes are made.

The reverse charge applies to most services, but not all. “For example, services that would be exempt if purchased in the UK are not subject to the reverse charge,” Robert says. Also, reverse charge VAT that is wholly attributable to a taxable supply may be reclaimed in full. If VAT has been over declared, a retrospective claim can be made.

To find out more or to arrange a review of your reverse charge accounting and systems, contact us.

This is the second in a series of four articles on partial exemption issues. Watch out for our next article concerning the capital goods scheme rules.