On 5 November 2012, HMRC issued guidance (currently only available on request) on valuing Reverse Charge supplies within VAT groups. The guidance will be important for VAT groups which make exempt supplies and use the services of an overseas member (e.g. financial service providers, charities, landlords, etc.).
What is the Reverse Charge?
A Reverse Charge is usually triggered when businesses purchase services from overseas suppliers. The standard mechanism is for an overseas supplier to charge no output VAT on its sales invoice. Instead, output VAT on the transaction is accounted for by the customer in its own UK VAT return, which is then reclaimed by the customer as input VAT in the same VAT return in accordance with the normal rules. In effect, the customer charges VAT to itself, as if for a self-supply.
In 2010 the Reverse Charge was placed at the heart of the European VAT system. Its widespread use has prompted HMRC to put forward new legislation, to which this new guidance relates.
What is a VAT group?
A VAT group is a group of companies (‘members’) which meet specific criteria. The VAT group has one VAT registration number and one VAT return on which to record the transactions all members within the group have with third parties. Supplies between members, however, are usually outside the scope of VAT.
Planning opportunity for businesses making exempt supplies?
The Reverse Charge usually results in no VAT liability for the recipient of the services (customer): whatever output VAT it charges to itself under the Reverse Charge, is usually fully reclaimed as input VAT on the same VAT return.
However, a VAT liability can arise under the Reverse Charge if the customer is not permitted to reclaim all its input VAT (e.g. if it makes exempt supplies). In practice, an overseas supplier will issue a sales invoice with no VAT charged to the UK business customer, but because the customer cannot reclaim all the output VAT it charges to itself, it will have a VAT liability to HMRC.
One solution, provided the criteria for group registration are met, is for the exempt customer to enter into a VAT group with the overseas supplier, so that the supply falls outside the scope of VAT as a supply between members of the same VAT group.
Some businesses realised that all their purchases (from UK or overseas) could be made by an overseas member without suffering a UK VAT charge, and then recharged free of VAT to the UK member for use in the VAT group’s exempt activity. Therefore, in 1997, HMRC introduced anti-avoidance rules to impose a Reverse Charge on services supplied by an overseas member to a UK member.
What is the impact of the new guidance?
Unfortunately, the anti-avoidance legislation went further than intended, resulting in VAT charges on services generated within the VAT group. Finance Bill 2012 gave legislative effect to HMRC’s Extra Statutory Concession 3.2.2, relieving the unintended VAT charges.
HMRC’s new guidance explains that the Reverse Charge within VAT groups is restricted to that part of the intra-group purchases (by the UK member from the overseas member) which is a “direct cost-component” and which has been “bought in” by the overseas member. No Reverse Charge will apply to the overseas member’s “overheads” and “own resources” when charged to the UK member. It will therefore be necessary for UK members to be able to distinguish between the two elements within any services purchased from overseas members.
HMRC’s guidance goes on to explain what is meant by these terms. For example, “own resources” would include the operational costs of the overseas member, such as its own staff and office costs. A “direct cost-component” is a service which the overseas member has bought in which has a direct and immediate link to the charge made to the UK member. Of course, this only substitutes one complex term for another, so the guidance also explains “direct and immediate link”, but only in vague terms such as “a sufficient link between the cost and the onward supply”. Each case should therefore be considered on its own merits.
The HMRC guidance also considers more unusual scenarios, such as “trifling charges”. The most helpful of these is a reminder that not all services purchased from overseas suppliers are subject to the Reverse Charge: for example, land-related supplies (such as building management charges) are subject to VAT in the country where the land is located.
In summary, the Reverse Charge is often misunderstood even in standard transactions. When it is applied to intra-group transactions, additional complexities arise from the need to divide the purchase into a part which is subjected to the Reverse Charge and a part which remains outside the scope of VAT.