Reverse Charge

Reverse charge is a tax mechanism where the tax liability is on the recipient of the service or the buyer of the goods, rather than the service provider or the seller of the goods. This system is primarily used for VAT to reduce the possibility of fraud and to simplify tax collection.

The application of reverse charge means that the buyer must declare and pay VAT on the value of the goods or services instead of the seller doing so. This system is common in the European Union for certain goods and services, especially in the case of cross-border transactions.

Read more: VAT information

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When applying reverse charge, the VAT rate for the goods or services does not change. Instead, there is a change in who fulfills the tax obligation. If reverse charge is applied to a transaction, the buyer must declare and pay VAT at the applicable rate. For example, if the transaction subject to reverse charge involves a product with a standard VAT rate, the buyer must declare and pay 22% VAT.

Check other VAT rates on the attached page: Estonian VAT Rates 2024.

When purchasing goods or services from suppliers located in other EU countries, the reverse charge mechanism shifts the obligation to account for the VAT transaction from the seller to the buyer of the goods or services. This eliminates or reduces the seller’s obligation to register for VAT in the country where the supply is made. If the supplier incurs local VAT on costs related to the services or goods supplied under reverse charge, they may reclaim it through the EU VAT refund system.

When applying reverse charge, it is important to ensure that the invoice contains all the required information.

Read more: Tax and Customs Board

The invoice must refer to § 41 of the VAT Act and indicate “domestic reverse charge” (domestic reverse charge), which is also present on the issued invoice. The VAT amount is shown on the invoice, but only the transaction amount excluding VAT should be paid. Reverse VAT must be applied to the sale of real estate, metal waste, precious metals, and metal products.

If a supply is subject to reverse charge, the invoice must state “reverse charge” regardless of whether the supply is exempt or taxed at a 0% rate. Additionally, the invoice must mention “reverse charge” when the place of supply is in another member state where extensive reverse charge is applied (under Directive 2006/112/EU, Article 194) and, therefore, the seller or service provider is not required to register for VAT in the other member state. It is crucial to check that the business partner has a valid VAT number when issuing the invoice. This can be verified through the European Commission’s VAT Information Exchange System.

Under the reverse charge mechanism, the recipient of the goods or services declares both their purchase and the supplier’s sale in their VAT return. Thus, two entries in the same return cancel each other from a cash payment perspective. Authorities see the transaction in the special fields provided for cross-border goods or services in the VAT returns.

One area that may cause an obligation to register for VAT is when EU businesses, not registered for VAT (as they have no taxable supplies), receive services from outside Europe. Reverse charged services count towards their VAT registration threshold. This means companies like holding companies are now listed in the VAT register and face input VAT that cannot be reclaimed as they have no VAT-taxable supplies.

Reverse charge was introduced for several reasons, primarily to address certain issues related to tax fraud and to simplify the tax collection process. The main reasons and benefits are as follows:

• Combating Tax Fraud: In the traditional VAT system, there can be situations where the seller collects VAT but does not remit it to the government. With reverse charge, the buyer declares and pays the VAT, reducing opportunities for such fraud.
• Preventing VAT Deduction Fraud: Reverse charge helps avoid situations where the buyer claims back VAT that the seller has never paid to the government. Since the buyer declares the tax obligation in reverse charge, the risk of unpaid VAT to the state is minimized.
• Simplified Tax Administration: Tax authorities find it easier to monitor and control a large number of buyers, especially larger companies, than a large number of small sellers. This reduces administrative burden and increases the efficiency of tax collection.
• Cross-border Transactions: Reverse charge is particularly useful for intra-EU cross-border transactions. It avoids complex tax collection processes that arise when goods move from one member state to another. The buyer, located in another country, declares and pays VAT according to their country’s laws, simplifying and harmonizing the taxation of cross-border transactions.
• Reduced Risks for Sellers: Reverse charge reduces the risks for sellers as they do not have to worry about collecting and remitting VAT. This can make the sales process simpler and clearer.

In summary, reverse charge helps ensure a fairer and more transparent tax system, reduces opportunities for tax fraud, and simplifies the tax collection process for both the government and businesses.