Partial exemption trap when buying services from abroad

Place of supply

The general business-to-business (B2B) rule has always been that the place of supply for most services is where the customer is based. So, an Irish consultant charging fees to a VAT-registered entity in the UK will not charge Irish VAT as the place of supply is the UK. This situation is unchanged by Brexit.

Even if a UK customer receiving services is non-profit making, such as a members’ golf club, it is still classed as being “in business”. Its VAT registration number is the best evidence of its business status.

VAT reporting

Our trader confirms that the specialist’s fees had been included as an expense in Box 7 of each VAT return, i.e. the “inputs” box. No other entries have been made. Unfortunately, they made a big error here. They should have accounted for VAT on these invoices by doing a reverse charge calculation in Boxes 1 and 4.

The trader must carry out a reverse charge calculation on any services the business has received from abroad. This has always been the case, and there has never been any difference in the VAT treatment between buying services from an EU or non-EU supplier so the mention of Brexit is a red herring. For example, buying services from an Indian-based supplier is treated in the same way.

Partial exemption

The problem is that the business is partially exempt with an input tax restriction on its costs. The recovery rate is apparently only 30% on expenses that are relevant to both taxable and exempt sales, such as the consultant’s fees. This means that errors have been made on past VAT returns that have resulted in underpayments of VAT.

Example. Rory the consultant in Ireland has invoiced ABC Golf Club for £24,000 of consultancy fees in the last twelve months, a fee that is relevant to both the taxable and exempt activities of the club. The club’s input tax recovery rate on “mixed costs” is 30%. Rory raises a monthly invoice for £2,000. ABC will make the following entries on its VAT return for each invoice received from Rory:

Box 1 - output tax - £400, i.e. £2,000 x 20%.

Box 4 - input tax - £120, i.e. the VAT in Box 1 less a partial exemption restriction of 70% of the VAT.

Box 7 - inputs - £2,000, i.e. the net value of the expense.

VAT errors on past returns need to be corrected for the last four years. If the net amount of VAT is more than £10,000, the trader will need to separately notify HMRC of the errors as a disclosure, which will be subject to interest for underpayments. This is usually done by completing Form VAT652.

If the net amount of VAT underpaid is less than £10,000, it can be included on the next return. But the trader should still consider telling HMRC about the adjustment in writing if the error might be classed as careless to avoid a potential penalty on a future compliance visit.