Why you should understand the ‘hidden’ danger of the VAT reverse charge

Does your organisation make purchases of services from overseas? This is a common question we ask and it is easy to assume that the answer is no. But the consequences for getting this wrong can be significant. VAT at 20% could be due on the value of purchases which, depending on the organisation’s VAT status, could be fully irrecoverable and represent a sizeable additional cost.

It can be very surprising how many different services can be provided by organisations that are based outside the UK and are not registered for UK VAT. Frequent examples are:

  • IT services, such as video calling facilities or software licenses
  • Social media advertising, such as Meta (Facebook/Instagram) and Twitter
  • Payment processing providers (such as Stripe)
  • Consultants

Why does it matter if my charity makes a purchase from overseas?

If you make a purchase of services from a supplier based overseas who isn’t registered for UK VAT, then your purchase is potentially within the scope of the reverse charge for VAT. This can have some significant complications:

  • It can result in some non-VAT registered organisations having to register for VAT
  • An additional ‘hidden’ VAT cost of up to 20% on overseas expenditure.

The reverse charge doesn’t apply to all purchases of services from overseas, just those where the ‘place of supply’ is the UK. The rules around this are complex and will need to be understood in more or less detail depending on your organisation’s individual circumstances.

Your organisation is not VAT registered

If your organisation is not VAT registered, then certain purchases from overseas will count towards your VAT registration threshold and you may have to registered for VAT. This will be the case if your organisation qualifies as a ‘business’ for VAT purposes – i.e. if it has any business activities. In general, if you supply any services in return for remuneration, then you will qualify as a business for VAT purposes. This could be as obvious as a contract for services, or something less obvious such as renting out spare office space, making a management charge to a trading subsidiary or income earned from services provided at a qualifying fundraising event.

If however your organisation has no business activities then you are not within the scope of the reverse charge and you will not be required to register for VAT. This does mean that some overseas suppliers may now be required to charge your organisation UK VAT. You should ensure that, when making purchases, you do not state that the purchase is for business purposes. For example, this is a question asked when placing an advert on Facebook – if you state that it is not for business purposes, UK VAT will be charged.

Charity that carries out care services funded by contracts from local authorities as well as donations/grants.

  • It qualifies as a business as it delivers services under contracts however these are all exempt from VAT.
  • Otherwise, it only receives non-business, donation funding
  • It incurs £90,000 of spend with an IT consultancy firm based in Ireland.

The spend is within the scope of the reverse charge, so £90,000 is added to the total taxable turnover figure (currently £0 – since all contract income is exempt). However, this value of spend exceeds the VAT registration threshold of £85,000, so the charity must register for VAT. If the charity expected the same level of consultancy spend next year, it would be required to account for £18,000 of reverse charge VAT. Since the charity only has non-business and exempt income it cannot recovery any of this VAT.

Your organisation is VAT registered

Even if you are already registered for VAT, it can be very costly to not apply the reverse charge correctly. If you are VAT registered, you must account for the reverse charge on purchases from overseas where the place of supply is the UK.

This means that:

  • You must identify all spend with overseas suppliers of services where the reverse charge applies.
  • You must account for output VAT at the relevant rate on the value of the purchase. So if you purchase IT services for £1,000, this will be subject to output VAT at 20% of £200, which is payable to HMRC.
  • The output VAT of £200 is also treated as input VAT. This is recoverable based on the usual VAT recovery rules based on what activity the purchase supports.
  • If for example the purchase supports only non-business activities then the input VAT is irrecoverable. This results in an additional net spend of £200.

What do I need to ensure my organisation is doing?

We have summarised the key steps to carry out in relation to purchases made from overseas.

1. Establish whether or not your organisation qualifies as a ‘business’ for VAT purposes.

  • If it does not, then there is no requirement to apply the reverse charge. If a ‘business’ – ensure you have a system in place to identify overseas suppliers, including providing appropriate training to relevant members of staff. This can be particularly challenging for payments for IT services made by debit/credit card.

2. Review transactions with overseas suppliers to identify any within the scope of the reverse charge.

  • If not VAT registered – ensure that the total spend potentially subject to the reverse charge is added to taxable turnover when calculating if the charity needs to register for VAT.
  • If VAT registered – account for output VAT on reverse charge purchases on the VAT return. Also account for input VAT and calculate recovery in line with the usual recovery rules based on usage of the purchase.

We have more detailed guidance on VAT relating to international transactions in our ‘International Aspects of VAT Made Simple’ guide available on our website, as well as discussing this topic in a webinar – see this page for details of how to request a recording.