The reverse charge mechanism impacts many FreeAgent customers who buy services from countries other than the UK. As of March 2014, FreeAgent calculates the reverse charge and automatically adds it to your VAT return for transactions entered as EC Services.
What is the reverse charge?
If you buy services (not goods) from countries other than the UK, and you belong in the UK, then you may have to use the reverse charge mechanism to account for VAT.
Services that you sell abroad don't come into this equation, because the service is outside the scope of UK VAT if your customer is a business. If your customer is an end consumer, you would account for VAT on the sale of that service either using UK VAT rates, or, in some cases, VAT rates local to the customer.
How FreeAgent handles the reverse charge for services from the EU
Here is what FreeAgent will do for you automatically when you are buying services from the wider EU, so long as you have posted these costs into FreeAgent correctly, whether you bought these services as bills, expenses, or bank payments. Remember to set the VAT rate as 0% when you enter these costs. Let's say the service cost £100:
- FreeAgent will work out the VAT you would have paid on that service if you'd bought it from a VAT-registered supplier in the UK. In this case that would be £100 x 20% = £20.
- That amount (in this case £20) will be added to box 1 on your VAT return.
- It will also be added to box 4 on your VAT return, assuming you're entitled to claim this VAT back.
- The net amount (in this case £100) will be added to both boxes 6 and 7 of your VAT return.
The reverse charge is accounted for in the same way regardless of whether you are using the VAT flat rate scheme.
How FreeAgent handles the reverse charge for services from outside the EU
If you buy services from outside the EU and the service doesn't have UK VAT on it, then you have two options.
The easier option is to enter the cost as bank payment or expense and tag it as EC Services, so that FreeAgent accounts for the VAT automatically.
The second option is that after creating your bill, bank payment or expense, you will need to enter some journals and bank transactions to account for the reverse charge. You can only use this option if you're not on the flat rate scheme. If you're on the Flat Rate Scheme, you need to use the first option.
When not on the Flat Rate Scheme: option 2
Let's say the service cost £100:
- Work out the amount of UK VAT you would have been charged on that service if you'd bought it from a VAT-registered supplier in the UK. In this case that would be £100 x 20% = £20
- Create a manual bank account entry with the same value as your purchase, in this case that would be for £100 explained as Type = Sales and Category = Sales. Set the VAT rate to 0%
- Create another manual bank account entry, but this time set Type = Sales Refund and Category = Sales. Set the VAT rate to Out of Scope on this occasion.
You will now need to enter some journals to complete the process.
- Debit (DR) code 818 for £20 and Credit (CR) code 819 for £20
The result of entering these entries will be that box 1 and box 4 of your VAT return will increase by £20 and box 6 and box 7 will increase by £100.