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How does the reverse charge on VAT work?

The entire regulatory structure around taxation is sure to complicate matters for any business. In order to simplify and streamline part of the process, though, the European Union came up with the reverse charge on VAT. This is one way in which the entire system is made a little easier to implement.

The basics of the reverse charge on VAT

The reverse charge on VAT was introduced when the EU launched its single market in 1993, to make the tax reporting setup simpler. In essence, with this mechanism, the burden of recording a VAT transaction is shifted from the seller to the buyer when it comes to cross-border supplies.

First and foremost, this eliminates the need for suppliers to register for the tax in numerous countries across the European Union. Secondly, if a business provides a cross-border supply of a good or service that falls under this scheme, it can reclaim the local tax charged on its costs of production and reduce its expenses.

When the reverse charge on VAT is in effect, the buyer of a good or service records both the input and output value-added tax charges in their VAT return, cancelling both the entries in effect. The authorities in the buyer’s country can see which transactions these were since there’s a designated section for cross-border supplies on the document.

Which goods and services does this apply to?

There are a few select instances during which the reverse charge on VAT is applied.

  • Intra-community supplies of goods
    • When items are sold to a VAT-registered business in another country, the inverse condition needs to be fulfilled in all instances.
  • Supply of services
    • When services are provided to a VAT-registered business in another state, the reverse charge on VAT has been required since 2010 in the EU.
  • Domestic supplies
    • This is only applicable in some member states.

As you can see, the scheme is only applied in a business-to-business environment, ignoring B2C transactions. In addition, the European Commission has given individual states the right to impose variations of the law within a certain framework. Make sure you consult a local professional to understand the nuances of domestic regulations.

The objectives of the mechanism

As we discussed earlier, one aim of the reverse charge on VAT is to simplify the tax system. By reducing the amount of red tape and administrative protocols businesses attend to, bureaucratic costs fall dramatically.

Secondly, this system clamps down on criminal activity, specifically a type known as missing trader fraud. This is where a few traders manage to reclaim input charges while failing to pay the output tax owed to the government. Here’s an example.

In Germany, Business A sells goods to Business B in the UK without including VAT details in the invoices. Business B then sells these goods to Business C, also in the UK, including the proper tax info. In this case, Business C gets an input tax refund, but before Business B pays its output charges, it disappears. This is a system whereby governments are defrauded since an entrepreneur in the middle of the scheme earns input charges while the government fails to claim fees owed to it. The process can be taken further in a carousel scheme. This is where Business C in the UK then sells to Business A in Germany, and a circular criminal process develops, with someone else coming in to fill Business B’s void.

A 2018 report by the European Commission found that around €50 billion is lost annually through missing trader and carousel fraud. The reverse charge on VAT cuts down on these forms of criminal activity since buyers need to list both the input and output value-added taxation charges.

Key takeaways

While both regional and national authorities are taking measures to make the business environment more straightforward and uncomplicated, there is still more work that needs to be done. We at VAT4U have stepped in with an automated cloud platform that does all the heavy lifting for you in one avenue. The value-added tax recovery process has been offloaded to machines so that minimal human involvement is required.

See how our service works and try it out for free.

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