What Is Reverse Charge VAT, and Why Does It Catch Not-for-Profits Out?

If your not-for-profit buys services from suppliers outside the UK, such as software subscriptions or overseas freelancers, you may have to account for UK VAT on them yourself. This is called the reverse charge. The catch is that the cost of these services counts towards the £90,000 VAT registration threshold, so an organisation that sells nothing at all can still be forced to register for VAT, and may end up paying an extra 20% that it cannot claim back.

Normally, your supplier charges you VAT and pays it over to HMRC. When the supplier is based outside the UK, they do not charge UK VAT. So instead, HMRC treats it as though you supplied the service to yourself, and you have to account for the VAT, usually at 20%.

The rule exists so that buying from abroad is not cheaper than buying from a UK supplier who would have to charge VAT. It is not aimed at not-for-profits, but they are often the ones who get caught out by it.

Common examples include:

•         Cloud software and subscriptions

•         Overseas freelancers and consultants

•         Virtual admin and outsourced support

•         Hosting, domain and web services

•         Online training and marketing tools

Tip: check who actually invoices you. Some well known software providers bill from a UK company and charge UK VAT, while others bill from overseas with no VAT on the invoice. The invoice will tell you which you are dealing with.

Many not-for-profits assume VAT does not apply to them because their income is mostly grants and donations. If you are not selling training, consultancy or other services, VAT can feel irrelevant.

But the value of overseas services you receive under the reverse charge counts towards the VAT registration threshold of £90,000, measured over any rolling 12 month period. If your overseas spend reaches that level and your organisation carries out some business activity (more on this below), you must register for VAT, even if:

•         Your income is mostly grants or donations

•         You do not sell anything that VAT is charged on

•         You were never planning to reclaim any VAT

This is an important exception. The reverse charge only applies if your organisation carries out some business activity. If you are solely funded by grants and donations and have no business activity at all, you are generally outside the reverse charge, and your overseas spend does not count towards the VAT threshold.

But it does not take much to bring you within the rules. Business activity can include things like:

•         Contracts or service level agreements, for example delivering a service for a local authority

•         Selling training, consultancy, events or merchandise

•         Renting out space or equipment

•         Some types of sponsorship

Even a small amount of this kind of income can mean the reverse charge applies to all of your overseas services.

This one catches organisations out too. Just because something is called a grant does not mean HMRC will treat it as one. If the funder receives something specific in return, such as you delivering a service on their behalf, it may be treated as payment for service delivery. That counts as business activity, and it can bring you within the reverse charge even if all your funding is described as grants.

A true grant funds your own work, and the funder gets nothing directly in return. Asking you to report on how the money was spent or what impact it had does not usually change that. Signs a grant may be treated as service delivery include:

•         The funder is paying you to deliver a service they would otherwise have to provide themselves

•         The agreement reads like a contract, with specific outputs delivered to the funder

•         The funder owns or uses what you produce, such as reports, research or materials

•         Payment is made against invoices rather than in grant instalments

Tip: read your grant agreements carefully before you sign, and check the wording. If an agreement looks more like a contract for services, get advice. It can affect your VAT position well beyond that one grant.

If you are not sure which side of the line you fall on, get advice before you assume you are outside the rules.

Say your organisation spends the following with overseas suppliers over a year

That organisation has reached the threshold and must register for VAT, even though it has not sold anything.

Once you are registered, you have to account for VAT on those overseas services. On £90,000 of spend, that is £18,000.

A VAT registered business that sells taxable goods or services can usually reclaim this straight back, so it costs them nothing. But if your organisation does not make taxable sales, you cannot reclaim it. That £18,000 becomes a real cost, effectively adding 20% to everything you buy from overseas.

For not-for-profits working to tight budgets, this can blow a hole in project costs, grant budgets and forecasts. And if you register late, HMRC can backdate the registration and add penalties on top.

1.      Identify your overseas suppliers. Go through your spend and flag every supplier based outside the UK. Check the invoices rather than assuming.

2.      Track the total on a rolling 12 month basis. The threshold is not measured by financial year, so keep a running total for the last 12 months and check it regularly.

3.      Get advice early if you are getting close. There may be ways to manage or reduce the exposure, such as restructuring services, reviewing your supply chain or using a UK supplier instead.

4.      Budget for it. If a project relies on overseas suppliers, build the potential VAT cost into the project budget and your funding applications.

When does the reverse charge apply?

It applies when your organisation buys services from a supplier based outside the UK and you carry out some business activity, even if most of your work is charitable. The supplier does not charge UK VAT, so you account for it instead.

Does the reverse charge matter if we're not VAT registered?

Yes, and this is where most not-for-profits get caught out. The value of overseas services counts towards the £90,000 VAT registration threshold, so if your organisation has some business activity, you can be required to register even if you do not sell anything that VAT is charged on.

Can we reclaim the VAT?

Only if, and to the extent that, it relates to taxable sales you make. If your income is mainly grants, donations or exempt income, most or all of the VAT will be a real cost to your organisation.

Does the reverse charge apply if we are solely grant funded?

Generally not. If your organisation is funded only by grants and donations and has no business activity at all, the reverse charge does not usually apply. But income such as contracts, sales, room hire or some sponsorship can bring you within the rules, and so can grants that are really payment for service delivery, so it is worth checking.

What happens if we get it wrong?

If you should have registered and did not, HMRC can backdate your registration, ask for the VAT you should have accounted for, and charge penalties and interest.

If you are not sure whether the reverse charge applies to you, or how close you are to the threshold, let's have a chat. The Moneypad NFP team can review your overseas spend, tell you where you stand and help you plan ahead so you are not caught out. Fill out the form below to get in touch.