What is VAT reverse charge?
VAT reverse charge (definition)
VAT reverse charge is when a buyer in the supply chain adds and collects VAT instead of the seller.
Usually it’s the seller’s responsibility to add and collect VAT when they sell a product or service. In the case of VAT reverse charge, that job falls to the buyer. This form of VAT accounting is most commonly used in the UK construction industry.
Domestic reverse charge (DRC) in the construction industry
Contractors who participate in the Construction Industry Scheme (CIS) commonly use Domestic Reverse Charge (DRC).
Under this scheme, subcontractors don’t charge VAT on services they provide to the main contractor. Instead, the main contractor is responsible for calculating the VAT, reporting and paying it to HMRC.
What is the CIS?
The CIS was initially created so that the main contractor on a job can deduct income tax from subcontractor invoices. These deductions act as advance payment towards the subcontractor’s tax and insurance, helping to spread the cost throughout the year.
Contractors within the CIS are also subject to VAT domestic reverse charge. If the services they supply or purchase are on HMRC’s reverse charge VAT list then they should send and receive reverse charge invoices.
How does VAT reverse charge work?
- The subcontractor (the supplier) sends an invoice for their services (without VAT added). For items that would normally attract VAT, the supplier notes that VAT reverse charges apply.
- The main contractor (the customer) pays the invoiced amount.
- The main contractor calculates how much VAT would have applied and adds that amount to their VAT liabilities.
- The main contractor claims back the VAT when doing their return, just as they would have if the supplier had charged VAT.
To ensure this process goes smoothly, the main contractor needs to check that incoming invoices correctly identify where reverse charge applies. They will also need to account for the VAT themselves and report it on their VAT return. Accounting software like Xero can help automate this process.
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.