If you are selling your products and services to customers in another EU country, you need to follow special VAT rules that differ from the ones if you were selling to customers domestically. This is especially important if you are dealing with foreign business customers, so in the case of B2B (business-to-business) transactions.
Also, if you are buying products or services for business-related purposes from another company within the EU territory, you will be subject to a special taxation scheme called the EU intra-community reverse charge mechanism.
What Is The EU Reverse Charge Mechanism?
A reverse charge mechanism is a system within the EU that is introduced to simplify the taxation of intra-community transactions for both suppliers and buyers. This mechanism also supports the EU's idea that all products and services must be taxed in a Member State where they are consumed.
In the case of a reverse charge mechanism, the buyer of products is liable to pay the VAT instead of the supplier. It is important to note that the EU reverse charge mechanism applies only to goods and services purchased for business purposes.
How Does The EU Reverse Charge Mechanism Work?
As already mentioned, if you have sold your goods and services to another EU Member State or purchased from another EU Member State, the reverse charge will apply.
The supplying party in the transaction (seller) must issue an invoice without a VAT amount and note that the reverse charge mechanism applies to the transaction. It is also essential to add the buyer's EU VAT number since it's crucial to shift the tax liabilities to the buyer. When the buying party (buyer) receives the invoice, it must record the buying VAT (input VAT) and the supplier's VAT (output VAT) on their VAT return for that period. The reverse charge VAT will cancel once the buyer submits the VAT return for that period.
For example, let's assume that you are a VAT registered business in Germany, and you purchase some services from your business partner in Italy. As a supplier in this transaction, your business partner in Italy will issue an invoice without a VAT, but with a note that the reverse charge mechanism applies to the transaction. The gross amount will be equal to the net amount because a VAT will not be applied. In that case, you are obliged to report this transaction to German tax authorities on your VAT return by adding both the input VAT (your VAT) and output VAT (supplier's), which will cancel out the VAT on your return.
Example Of The Transaction Under The EU Reverse Charge Mechanism
We will follow the same example as above - the supplier is from Italy, the buyer is from Germany, both businesses are registered for VAT purposes.
The supplier issues an invoice without a VAT in the amount of EUR 1000 and adds a note that the reverse charge applies to the transaction. The buyer will pay EUR 1000 to the supplier as per the invoice. At the beginning of the next VAT return period, the buyer will manually apply German VAT (19%) on the EUR 1000, so the VAT will be EUR 190. These 190 EUR are reported under the sales section as an output VAT and under the purchase section as an input VAT.
What Happens If One Or Both Businesses Are Not Registered For VAT Purposes?
Application of the reverse charge mechanism depends on the buyer's tax status, and there are four possible scenarios in the case of direct B2B transactions between buyer and seller.
- Both buyer and seller are registered for the VAT purposes in their countries - the EU reverse charge applies
- The buyer is registered for VAT purposes, but the seller is not - the EU reverse charge applies
- The buyer is not registered for VAT purposes, but the seller is - the EU reverse charge doesn't apply
- Both buyer and seller are not registered for the VAT purposes in their countries - the EU reverse charge doesn't apply
All these scenarios are applicable when transacting goods, but what happens in the case of providing services?
When supplying services within the EU territory, all B2B transactions are subject to EU reverse charge, regardless of the VAT status of parties.
How To Issue An Invoice Under The Reverse Charge Mechanism?
Fonoa can help you to operate compliantly with all applicable VAT regulations.
Fonoa Invoicing supports the issuance of fully tax compliant invoices in 60+ countries, including all EU Member States. Our solution will automatically detect the B2B transaction and apply the relevant taxation rules, including the EU reverse charge.
Even more, before the transaction takes place, it is crucial to validate your business customer's EU VAT number. We already discussed how important this is, and that's why we built Fonoa Lookup. With Fonoa Lookup, you can validate your business customers' tax numbers in more than 60 countries directly from the government's databases and avoid possible additional tax liabilities for your business.
Reach out to us, and we can help you automate your invoicing process and comply with the EU VAT reverse charge mechanism.