If your company sells products or services to a client in another EU country, the VAT process is different from if you were selling to a client domestically. The same system applies if you are buying products or services from another EU country. The system is called “reverse charge on EU VAT” which simplifies VAT within the European single market.
Since intra-EU transactions are so common, we’ve laid out the specifics for you. We’ll explain what these transactions mean for both VAT registered, and non-VAT registered businesses, how to record the transactions on your invoicing software, and examples of how they work.
What is an intra-EU trade?
The term “intra-EU trade” refers to any transaction where goods or services are sold from one EU country to another. If your company operates in the UK, and you sell products to a client in Germany, this is considered an intra-EU transaction.
Intra-EU trade charges VAT differently than if you were to trade domestically within your country. If your UK business purchases products from Germany, or another EU country, this is an intra-EU transaction in which reverse charge VAT will apply.
Only European Union member states within the European single market are part of the reverse charge system. Therefore, Norway, Iceland and Liechtenstein are excluded. The only exception to this is Switzerland, which has adopted many of the EU rules, including using the reverse charge mechanism only on a restricted list of goods and services under specific conditions.
What is the reverse charge mechanism?
The reverse charge mechanism is a system within the EU to simplify VAT in cross border sales, where the buyer of the goods or services is tax liable, instead of the supplier.
If you are a VAT registered business in the UK, you will need to report these transactions to HMRC on your VAT return by adding both the input and output VAT, which will cancel out the VAT on your return.
The reverse charge mechanism only applied to goods or services purchased for business-related purposes.
How does the reverse charge work?
If you have sold goods or services to another EU country, or purchased goods or services from another EU country, the reverse charge will apply, as long as the purchasing party is VAT registered.
The reverse charge VAT is inputted on the invoice and cancels out when the buyer submits their VAT return for that period.
The supplier will note on the invoice that the reverse charge mechanism applies to the sale. The recipient (buyer) will record both the purchase VAT (input VAT) and the suppliers’ VAT (output VAT) on their VAT return for that period. The two transactions will cancel each other out in the same VAT return.
In their VAT return, the purchaser is showing the tax authorities that: “I purchased this, and this is how much VAT I owe on it. However, I purchased it for business purposes, so I would get the VAT back anyways. I’ll just keep the money.” It is essentially a declaration that it was paid, and a refund for the payment all at once.
HMRC or your countries’ tax authorities will see the transaction reported, and recognise it as an intra-EU reverse charge transaction.
Most invoicing software will automatically mark these expenses as a reverse charge as soon as you input the country of origin, making it even easier to record this type of transaction.
Reverse charge for non-VAT registered businesses
The reverse charge mechanism is based solely on the tax status of the recipient of the goods or services since the VAT is transferred to the buyer’s country. I’ve outlined a few scenarios based on the tax status of both the buyer and supplier below.
If both the buyer and supplier are not VAT registered in their respective countries, then the reverse charge does not apply. Since the buyer and seller do not charge or report VAT, then no VAT is charged on these sales.
If the supplier is VAT registered, but the buyer is not VAT registered, the reverse charge does not apply. Since the reverse charge is based on the buyer’s tax status, and in this case, the buyer would not submit a VAT return, no VAT is charged or reported. The exception to this is if the supplies purchased make the buyer over the threshold to register for VAT. If it does, the buyer will need to register for VAT and apply the reverse charge.
If the buyer is VAT registered, but the supplier is not, then the reverse charge does apply. Since it is the responsibility of the recipient to account for VAT as if they were the supplier, if the recipient is VAT registered then they can report this on their VAT return.
Why do countries use the reverse charge mechanism?
The main reason that countries have adopted the reverse charge mechanism is that it simplifies the VAT process for intra-EU trade for both the supplier and the buyer.
Another reason is that it helps prevent tax fraud and tax evasion. This system ensures that no VAT is charged on intra-EU trade.
For example, if someone sets up a fake business, collects VAT and does not report it to the HMRC or the tax agency of their country, they could pocket the money and then disappear into thin air. This is difficult for tax agencies to regulate if suppliers are in foreign countries.
With the reverse charge system, this is impossible, as fake businesses would never receive the VAT, and therefore cannot pocket it and disappear. This system ensures that VAT stays in the domestic network.
How do I record reverse charge transactions on my invoicing software?
To comply with the reverse-charge mechanism, you will need to follow different steps, depending on if you are the supplier or the purchaser.
If you are the supplier selling the products to a client in another EU country, you will need to:
- Confirm the purchaser’s location and VAT registration number
- Enter the VAT rate as 0% and do not add any VAT/tax to the total cost
- Ensure the buyer’s VAT number is listed on the invoice
- Make a note on the invoice that you are using the reverse charge mechanism
If you are the purchaser buying the products from a supplier in another EU country, you will need to:
- Check the invoice to confirm that the VAT and total cost are correct
- Check that the invoice mentions that the reverse charge mechanism is used
- List both your purchase and supplier’s sale on your VAT report
Reverse charge invoice and expense examples
Here are some examples using Debitoor invoicing software. In these examples, a German supplier is selling products to a UK purchaser using reverse charge.
The first example is an invoice from the German supplier:
This example is how the UK purchaser will record the expense:
You can see on the invoice that the purchaser’s VAT number is showing, the VAT rate is set to 0%, and there is a note clearly stating that the transaction is using reverse charge.
On the expense example, you can see that the country is set to Germany, which automatically changes the VAT to reflect the reverse charge. With Debitoor invoicing software, you can also add a copy of the invoice to the expense for your reference.
Want to test it out? Feel free to give Debitoor a try with a 7-day free trial.