The EU created the concept of the reverse charge mechanism to make it easier for both sellers and buyers to account for the VAT correctly without requiring foreign VAT registrations or having to go through the arduous process of cross-border VAT recovery. Most sales between EU member states will be subject to a reverse charge. Furthermore, there are many instances where the domestic reverse charge rule exists within specific EU member states.
With whom does the VAT responsibility lie in a reverse charge transaction?
Put simply, the buyer.
However, we have a lot of explaining to do in order for that to make any sense.
Normally, the seller is obligated to account for their output tax. However, the reverse charge mechanism shifts the VAT obligation from the seller to the buyer when it comes to declaring and paying the VAT.
The rule states that the seller is not obliged to charge VAT on the transaction. Within the context of a cross-border transaction, this makes a lot of sense considering that the buyer is abroad and will not be able to claim that tax anyway, the tax authorities allow the seller to not charge it at all. In fact, the transaction is considered exempt from the seller’s perspective.
However, the seller will still have to declare the output VAT in his VAT return. It should be recorded as a reverse charge sale with no VAT on it because it’s technically exempt. In addition, the seller might also have to file an EC sales list in these situations (when the transaction is between two EU countries).
There are worse things than taxes. Like having to charge yourself tax.
In essence, for the VAT to be accounted for correctly, the buyer now has to calculate, impute and charge themselves the output VAT. To elaborate, the recipient of the goods or services must report both their purchase (input VAT) and the supplier’s sale (output VAT) in their VAT return. The silver lining is that in most cases these two declarations offset each other from a cash point of view, so there is no disruption to cash flow. Ultimately, this just gives the authorities full visibility of the transactions.
Calculating output VAT for the reverse charge mechanism
The buyer now has to calculate the output VAT (or what is often referred to as Acquisition Tax).
The formula to calculate the output VAT is as follows:
Seller’s country VAT rate/(VAT rate + 100) x value of goods.
Walking through a cross-border reverse charge scenario
Company A is based in Sweden. Company A sells goods or services to company B who is based in Germany. The good/service costs 200EUR and is subject to the reverse charge mechanism. The standard VAT rate in Sweden is 25%. The standard VAT rate in Germany is 19%.
Company B (the buyer) will have to account for the output VAT and the input VAT.
But Company A’s sales invoice isn’t showing a VAT amount because they were not obliged to charge VAT. The invoice clearly states reverse charged. Therefore, company B will have “charge themselves” output VAT or acquisition tax.
In this scenario, the calculation looks like this:
The output VAT (acquisition tax) is €40.
Company B calculates, imputes and accounts for the output VAT (€40 in their output VAT) section of their return. In addition, Company B must also offset the same amount (€40) in their input VAT return.
Ultimately, Company B has not been charged anything extra (just a few extra costs in resources and administration to orchestrate everything but we can assist you with that). However, they correctly remained compliant because they declared the VAT.
Exempt traders and reverse charge mechanism
If you happen to be a supplier who is an exempt trader (banks and businesses within the financial services industry), then you will not be entitled to claim the input VAT within the reverse charge mechanism.
This is because exempt traders do not have to charge output VAT to begin with. And therefore, tax authorities do not allow exempt traders to claim input VAT. Ultimately, for an exempt trader, the reverse charge mechanism means they will have to charge themselves the acquisition tax without claiming the input VAT.
The reverse charge mechanism makes logical sense when foreign businesses within the EU are transacting with each other. It simplifies the transaction process. The seller doesn’t have to register in a foreign country. And the buyer need not worry about trying to claim Foreign VAT through its local input VAT return (Foreign VAT recovery is done via the 13th and 8th directive which you can read more about here.)
If you are unsure of whether you are treating the reverse charge mechanism correctly, Vatglobal is able to offer assistance in all aspects of managed compliance. Speak to us today by emailing firstname.lastname@example.org.
Read more on the reverse charge and vat obligations here.