What is a Reverse Charge Invoice?
All VAT-registered businesses within the EU are obliged by law to charge VAT on their invoices. These invoices establish the supplier’s VAT liability as well as the customer’s entitlement to deductions for the VAT charged. Accurate representation of this part of the transaction is vital to avoid penalties for both parties.
Normally, the supplier collects VAT on their sales and remits it at the end of the tax period. However, when business occurs between two businesses that are based in two different EU countries, a reverse charge applies. In this scenario, the tax liability is reversed and it’s the buyer that records the VAT on the invoice.
Reverse Charge Example
Let’s first take a look at an example where a VAT reverse charge would apply. Suppose a German entrepreneur, ABC Company, has goods in a warehouse in Switzerland that they’d want to supply to XYZ Buyer in Zurich. As reverse charge transactions only apply to VAT registered businesses or legal entities, XYZ Buyer can’t be an individual customer. ABC Company then issues out an invoice that doesn’t include any tax rates and communicates that it’s a reverse charge invoice. As such, ABC will not be liable to pay VAT for this transaction, but XYZ Buyer is.
XYZ Buyer, therefore, only has to pay the net purchase amount to ABC Company. When completing their VAT return, XYZ will then manually calculate the VAT on the reverse charge invoice. This amount is reported as both input and output VAT, meaning it won’t have any effect on ABC and XYZ’s cash flow. However, there are instances where full deductions may not be possible according to partial exemption rules. These unique invoices can sometimes require different structures like in deposit invoices.
Why Is Reverse Charge Used?
The reverse charge was introduced in the EU to simplify VAT payments, save businesses from cross-border bureaucratic costs, and combat tax fraud. One of the most notorious fraud schemes that reverse charges have been effective in combating is the “missing trader”, where shipments would cross borders without paying VAT. Middlemen would include VAT when they sell the shipped goods, then disappear before the tax is due. The end-buyer would, however, claim a refund from the revenue office in the form of an input tax, thus potentially prejudicing countries of billions.
Reverse Charge Invoice Format
Selling goods or services across borders means that businesses have to create a reverse charge invoice to capture the unique VAT system. So what is a reverse charge invoice? What is it supposed to look like? Well, for a reverse charge invoice to comply with the law there is a set of mandatory information that has to be included on the invoice. If any of the required information is missing, the tax office may reject the invoice and possibly impose penalties as well.
A reverse charge invoice should include the supplier’s business address and VAT identification number. The same information should also be included for the recipient of the goods or services in question. A date of issue, as well as a consecutive invoice number, should also be included on the invoice. The supplier should also add a description of the products or services for which they are sending an invoice. They must also add a reference to the reverse charge procedure by adding a sentence along the lines of, “This invoice is charged without VAT because there is a reverse charge.” This sentence may have slightly different wording, depending on the country from which you are selling. This reverse charge format can follow either a traditional or simplified invoice template.