The reverse charge procedure has been designed by the HMRC to try to counter some forms of criminal attack on the UK VAT system by means of fraud, such as Missing Trader Intra-Community (MTIC) fraud.
The reverse charge procedure results in, essentially, a business-to-business (b2b) tax-neutral chain of transactions, with the seller no longer having to account for VAT, so it removes the opportunity to steal the VAT in b2b transactions within the UK. Supplies of relevant goods and services remain subject to the reverse charge until they are excepted from the procedure or are exported or dispatched to another Member State.
Whilst the reverse charge effectively removes VAT in a series of b2b transactions, it still has its own revenue risks. For example, a buyer disappearing without accounting for the reverse charge output tax.
The reverse charge for specified goods does not apply universally throughout the EU. Therefore, some taxable persons who use the reverse charge might be acting as conduits (taxable persons who facilitate MTIC fraud in the EU, where the tax loss is in another Member State).
The reverse charge: How the reverse charge works – an example
Example 1: From a VAT registered distributor to a retailer to an end consumer
A VAT registered UK distributor of mobile phones sells a number of mobile phones to a VAT registered UK retailer for a VAT-exclusive value of £6,000, an amount that is above the de minimis limit. The distributor does not charge VAT on the supply (£1,200), specifying on its invoice that the reverse charge applies.
The retailer will account for the distributor’s output tax (£1,200) but will also reclaim the amount as input tax, thus producing a nil net effect. The retailer now sells the mobile phones to members of the general public, charging VAT on the supply as normal.
Example 2: From a VAT registered distributor through a series of wholesalers to final dispatch
A distributor sells a number of mobile phones to a wholesaler (WS1) for a VAT-exclusive value of £6,000, an amount that is above the de minimis limit. The distributor does not charge VAT on the supply (£1,200), specifying on its invoice that the reverse charge applies.
WS1 will account for the distributor’s output tax (£1,200) but will reclaim the tax as input tax, thus producing a nil net effect. WS1 now sells the mobile phones to another wholesaler (WS2) for a VAT-exclusive value of £7,000. WS1 does not charge VAT on the supply (£1,400), specifying on its invoice that the reverse charge applies.
WS2 will account for WS1’s output tax (£1,400) but will reclaim the tax as input tax, thus producing a nil net effect. WS2 now sells the mobile phones to a third wholesaler (WS3) for a VAT-exclusive value of £8,000. WS2 does not charge VAT on the supply (£1,600), specifying on its invoice that the reverse charge applies.
WS3 will account for WS2’s output tax (£1,600) but will reclaim the tax as input tax, thus producing a nil net effect. WS3 now sells the mobile phones to a taxable person registered for VAT in another Member State for a VAT-exclusive value of £9,000. WS3 does not charge VAT on the supply as this becomes zero-rated.
If we look at how this would translate onto the VAT returns, we have:
Distributor WS1 WS2 WS3
Reverse charge output tax* £0 £1,200 £1,400 £1,600
Input Tax* £0 £1,200 £1,400 £1,600
Net Tax £0 £0 £0 £0
Outputs £6,000 £7,000 £8,000 £9,000
Inputs £0 £6,000 £7,000 £8,000
The above assumes that the distributor made no purchases and WS 1-3 made no other purchases or supplies.