VAT reverse charges – are you exposed despite being an FS business?

Even if a financial services business only has VAT exempt income and is not registered for VAT, there may still be a requirement to register for VAT; it’s all down to the VAT reverse charge.

VAT registration is required when taxable income is in excess of the registration threshold of £85,000. Taxable income in this respect is income which is subject to VAT at:

• standard rate (20%);
• reduced rate (5%); or
• zero rate (0%).

Exempt supplies do not count towards the VAT registration threshold.

Many financial services providers are exempt from VAT and therefore it is not unusual to find an FS business not registered for VAT even though its turnover may be in the millions. If its income is all exempt, registration is not required.

However, an area often not taken into account is the fact that taxable income also includes purchases which are subject to the VAT reverse charge.

The VAT reverse charge is a mechanism to ensure that VAT does not create an uneven playing field where international services are provided. Effectively an international supplier of services does not charge VAT and the liability to account for and pay VAT is transferred from the supplier to the customer. That way each customer accounts for VAT in their own country, as if they had been charged VAT from a domestic supplier.

Under the reverse charge procedure the customer is treated as if they made the actual supply themselves and as such this creates a potential VAT registration liability as the value of the services received counts towards the VAT registration threshold. Therefore, if the value of reverse charge services together with any other taxable supplies that a business may make, is over the VAT registration limit (currently £85,000 for the UK) the customer is required to register for VAT. To make it worse there is no time limit on how far back a VAT registration in this scenario can go. If you are already registered for VAT but have not dealt with reverse charges, only errors for the last four years have to be declared.

Typical services bought in and subject to the reverse charge for FS businesses include:

• IT services
• Consultancy
• Legal and
• Accountancy

This is not an exhaustive list. Ordinarily, any VAT accounted for under the reverse charge procedure would be recoverable but, if a company only makes exempt supplies, there is no ability to recover the VAT incurred. The reverse charge, therefore, creates a cost for exempt businesses.

To put that into context if you buy in services of £100,000 you are liable to register for VAT (if not already) and have to account for VAT of £20,000. For an exempt business, this VAT cannot be recovered and needs to be factored into any fees charged to your clients.

If you haven’t reviewed your bought in services and there is a historic liability it will be difficult to recover this VAT from your clients.

All is not completely lost. The reverse charge only applies to Business to Business (B2B) transactions and only where the supply being received is subject to VAT in the country of the customer. If the supply would be exempt if charged by a UK supplier, it will not count towards the VAT registration. For a FS business it may be that such bought in services could be exempt from VAT but not all.

If you buy in large amounts of services from outside the UK we would recommend a review to ensure that you do not have a historic VAT registration liability and a large VAT bill and can best manage any potential penalty issue.

Please contact our VAT specialists for more details.

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