What is it?
A reverse charge mechanism is a system within the European Union, which was introduced in order to simplify the taxation of intra-community transactions for suppliers and for buyers. When buying goods or services from suppliers in other EU member states, the Reverse Charges mechanism moves the responsibility for the recording of the VAT transaction from the seller to the buyer.
This mechanism was created by the European Union in 1993, when the European Union Value Added Tax system was reformed for the launch of the single market. It was introduced in order to simplify the VAT reporting across the EU member states.
How does the Reverse Charge mechanism work?
The Reverse Charge mechanism applies when you have sold goods or services to another EU member state or when you have purchased from another EU member state.
The seller must issue an invoice without any VAT and must note that the reverse charge mechanism applies to this transaction. It is also important to add the EU VAT Identification number of the buyer. This is needed for shifting the tax liabilities to the buyer.
When the buyer receives the invoice, he must record the buying VAT (input VAT) and the supplier`s VAT (output VAT) on his VAT return for that specific period.
Only B2B transactions can be subject to Reverse Charge as both parties do need to have a VAT identification number. Reverse Charge can not apply to B2C transactions/sales.
A business, which is VAT registered in Germany, purchases goods from a business partner in Italy.
The business partner in Italy (supplier), will issue an invoice without a VAT and will add a note that the reverse charge mechanism applies to this transaction. The gross amount will be equal to the net amount, because no VAT has been applied.
The German business (buyer), is obliged to report this transaction to the German Tax authorities by including this in his next VAT return. He has to add both - the input VAT and the output VAT.
In order to set up your invoice correctly, it is necessary to indicate the following information on the invoice:
- Address of the service provider
- VAT identification number of the service provider
- Information about the recipient of the service
- Date of issue of the invoice
- VAT identification number of the service recipient / tax number
- Consecutive invoice number
- Credit point (service date)
- Description of the service rendered (net amount, no tax rate or 0% indication)
- Reference to reverse charge procedure, for example: “*Invoice without VAT because there is a reverse of the tax liability (reverse charge)”, or you look for the appropriate paragraph of the reverse charge method in the country from which you are selling.
Please see attached an example of an invoice, where the reverse charge mechanism applies.
Please also read our blog for more information about this topic.