VAT Reverse Charge: How It Works

What Is the VAT Reverse Charge?

The VAT reverse charge is a mechanism where the customer accounts for the VAT on a purchase, rather than the supplier charging it. Instead of the supplier adding VAT to the invoice and paying it to HMRC, the customer includes the VAT in their VAT return as both output tax (Box 1) and input tax (Box 4).

The effect is that the VAT is self-assessed by the customer. If the customer can fully reclaim the input VAT, the net cost to them is zero — the two entries cancel each other out. The charge exists to prevent VAT fraud and to ensure the correct amount of VAT is accounted for.

When Does the Reverse Charge Apply?

The reverse charge applies in several situations in the UK:

Services Received from Overseas

When a UK VAT-registered business receives services from a supplier based outside the UK, the reverse charge applies under the place of supply rules. The UK customer must account for UK VAT on the purchase.

This applies to:

• Professional services (legal, accounting, consultancy) from overseas providers
• Digital services from non-UK businesses
• Advertising and marketing services from abroad
• Most other B2B services where the place of supply is the customer’s country

Construction Industry (Domestic Reverse Charge)

Since 1 March 2021, a domestic VAT reverse charge applies to supplies of certain construction services between VAT-registered businesses in the UK. This was introduced to combat missing trader fraud in the construction sector.

It applies when:

• The supply is of specified construction services reported under the Construction Industry Scheme
• Both the supplier and customer are VAT-registered
• The customer is not an end user or intermediary supplier connected to the end user

Other Domestic Reverse Charges

The reverse charge also applies to certain domestic supplies of:

• Mobile phones and computer chips with a VAT-exclusive value of £5,000 or more per transaction
• Emissions allowances and similar trading certificates
• Wholesale gas and electricity
• Telecommunications services (in specific circumstances)

How the Reverse Charge Works in Practice

Supplier’s Perspective

The supplier issues an invoice without VAT and includes a note stating that the reverse charge applies. The invoice must show:

• The amount excluding VAT
• A statement such as “Reverse charge: VAT Act 1994 Section 55A applies” (for construction) or “Reverse charge: customer to account for VAT”
• The supplier’s VAT number

The supplier does not include this supply in their output tax (Box 1). They do include the net value in their total sales (Box 6).

Customer’s Perspective

The customer receives the invoice and must:

1. Calculate the VAT that would have been charged (at the applicable rate, usually 20%)
2. Include this amount as output tax in Box 1 of their VAT return
3. If entitled to reclaim, include the same amount as input tax in Box 4
4. Include the net value in purchases (Box 7)

Accounting Example

A UK construction company receives an invoice for £10,000 from a subcontractor, subject to the domestic reverse charge:

The net VAT effect is £0 if the customer can fully reclaim input tax. However, if the customer makes exempt supplies and is partially exempt, they may not be able to reclaim the full amount.

Construction Industry Reverse Charge in Detail

The construction sector reverse charge has specific rules:

Which Services Are Covered?

• Building construction, alteration, repair, extension, and demolition
• Installation of heating, lighting, air conditioning, plumbing, and drainage systems
• Internal and external cleaning during construction
• Painting and decorating as part of construction
• Site preparation and clearance

Which Services Are Excluded?

• Architecture and surveying services
• Hiring of plant and machinery without an operator
• Manufacturing of building components off-site
• Delivering materials without installation
• Services provided to end users (the final customer who uses the building)

End User Notification

If the customer is an end user (they use the building for their own purposes and do not supply construction services onwards), the normal VAT rules apply — the supplier charges VAT. The end user should confirm in writing to the supplier that they are an end user.

Reverse Charge on Imports

When goods are imported into the UK, postponed VAT accounting allows businesses to account for import VAT through their VAT return rather than paying it at the border. This works similarly to the reverse charge:

• Import VAT is declared in Box 1 (output tax)
• The same amount is reclaimed in Box 4 (input tax), subject to normal recovery rules
• The monthly postponed import VAT statement from HMRC provides the figures

This is separate from the reverse charge but uses the same self-accounting principle.

Record Keeping

Businesses must maintain clear records of all reverse charge transactions, including:

• Invoices showing the reverse charge applies
• VAT return workings showing how the reverse charge amounts were calculated
• Evidence of the customer’s status (end user confirmations for construction)
• Records linking to your accounting system

These records must be kept for at least 6 years and maintained digitally under Making Tax Digital .

Common Mistakes

• Suppliers charging VAT when the reverse charge should apply — this results in the supplier paying VAT they should not have collected and the customer potentially reclaiming VAT they should not have been charged
• Customers failing to account for the reverse charge — this understates output tax and may trigger penalties
• Incorrect treatment of end users in the construction industry
• Not including the required reverse charge notation on invoices
• Failing to report the correct figures in the right boxes on the VAT return

Cash Flow Impact

The reverse charge has a significant cash flow effect:

• Suppliers no longer collect VAT on their invoices, meaning they receive less cash from each transaction. They may need to adjust their working capital
• Customers who can fully reclaim input tax see no change in their net position but must ensure their systems correctly process the reverse charge entries
• Businesses that are partially exempt may face a net cost because they cannot reclaim all of the reverse-charged VAT

Setting Up Your Accounting Software

Most accounting software packages include specific reverse charge functionality. When configuring your system:

• Create a separate VAT code for reverse charge purchases (often labelled “RC” or “Reverse Charge”)
• Ensure the code posts the correct entries to Box 1 and Box 4 simultaneously
• Test the code on a sample transaction before processing live invoices
• Verify that the VAT return report correctly populates all nine boxes

For construction businesses, separate codes may be needed for domestic reverse charge supplies at standard rate (20%) and reduced rate (5%).

Interaction with Other Taxes

The reverse charge is purely a VAT mechanism and does not affect corporation tax or income tax calculations. The expense is recorded at the net value for direct tax purposes regardless of how the VAT is accounted for. PAYE and National Insurance obligations are unaffected.