Self-assessed tax v VAT reverse charge: What’s the difference?
In the US, you’re probably familiar with the process of having to self-assess Use Tax on all purchases when the vendor has not charged you Sales Tax and the item in question is not exempt.
But across the pond in Europe – and, indeed, in any country that operates a VAT or GST system – this is usually referred to as reverse charge or Offset Tax. The reverse charge is used, much like the self-assessed Use Tax, when the vendor has not charged VAT but VAT is due.
So what’s the difference?
The answer is primarily based on the fact that VAT is recovered in (almost) all VAT and GST regimes, whereas in the US there is no concept of recovery. In the US, you either pay tax or you don’t and this is managed by the provision of exemptions. Meanwhile, in VAT/GST systems, you always pay tax – the only question to answer is whether you can subsequently recover it.
Still confused? Let’s take a look at an example:
1) US vendor
A US vendor does not charge Sales Tax as it has no nexus in your state and the amount is not exempt.
Use Tax: $80
When it comes to reporting the tax, you will simply pay the Use Tax to the appropriate tax authority.
2) EU vendor
An EU vendor does not charge VAT as your transaction is an intra-EU sale, meaning you (as the customer) have to apply a reverse charge, for example:
Now, this is where it gets interesting! The recoverable VAT on the payables portion is recorded on the purchase side, but the reverse part (the offset) is recorded on the sales side.
These two pieces of data are usually entered in different boxes on a VAT/GST return. Indeed, another reason to apply the reverse charge method is so that two tax lines are created – one for each of the boxes on the return.
If you are 100% recoverable, the net amount of VAT you pay to the tax authorities for the transaction in my EU example will be zero. This is because the amount of VAT on the sales side is netted to zero due to the full amount also being recovered.
Recoverable purchase VAT: €250
Sales VAT: €250
Net (paid to tax authority): €0
However, if you are not able to recover any of the VAT, there will be no recoverable entry on the purchasing side. Yet we still have the reverse charge element being added to the sales side.
Recoverable purchase VAT: €0
Sales VAT: €250
Net (paid to tax authority): €250
In this scenario, €250 has to be paid to the tax authority but nothing is recovered!
Of course, this outcome makes sense. Imagine if a company bought an item locally and was charged VAT, but was unable to recover the VAT meaning it becomes an expense.
If the same company was to buy an item from another EU country – and, for the purpose of this example, let’s assume there is no reverse charge concept – the VAT on the invoice would be zero and the business in question would actually save money by buying from abroad.
This shows the purpose of the reverse charge. By applying the reverse charge, the amount of VAT a customer has to pay will always be the same – whether they buy locally or from a foreign vendor.
There are some circumstances in which recoverability can be greater than 0% but less than 100%. In the example below where only 10% is recovered, the balance owing to the tax authority will be 90% of the total VAT.
Recoverable purchase VAT: €25
Sales VAT: €250
Net (paid to tax authority): €225
To summarise, when calculating a self-assessed tax, you will usually be faced with a single additional tax line on your tax return to record an expense. However, the reverse charge (or Offset Tax) is designed to create two tax lines – one positive and one negative – that can be recorded on the tax return in different boxes.