VAT on international supplies in financial services

This article aims to explain the principles and practices surrounding VAT on international supplies within the financial services sector, providing valuable insights for businesses aiming to navigate these waters effectively.

VAT treatment in international supplies

The VAT implications of international transactions hinge on the place of supply rules. These rules determine whether a supply is made in the UK or outside of it and, consequently, whether UK VAT is chargeable. Generally, the place of supply for financial services to non-UK customers is where the recipient belongs, making most of these services outside the scope of UK VAT. This can have significant implications for VAT recovery on costs.

Financial services businesses are largely exempt from VAT (our previous article here talks more about VAT exemptions).  If the businesses’ customers are outside of the UK, generally, the supply of services continues to be VAT exempt. The absence of VAT can make UK-based FS firms more attractive to foreign customers.

However, the VAT exemption for services provided to non-UK customers also means that related input VAT on costs incurred in providing these services may not be recoverable. This aspect underscores the importance of understanding the specific rules that apply to the financial services sector and how they impact VAT recovery strategies.

Exporting services to non-UK customers: Specified supplies

As per UK VAT legislation, specified supplies (referring to a defined set of services and intangible goods) exported to non-UK customers are still considered VAT exempt and any input tax incurred which is directly attributable to those supplies can be recovered in full.

In essence, specified supplies are subject to special VAT treatment when supplied between businesses across borders. This special treatment is designed to simplify VAT accounting for businesses operating internationally and to ensure that UK suppliers of financial services are not disadvantaged from a VAT perspective.

VAT on services received from non-UK suppliers: Reverse charge

In most cases, when UK businesses receive services from non-UK suppliers, the supplier will not charge UK VAT. However, in order to account for VAT, the reverse charge mechanism is applied. This shifts the responsibility for VAT reporting from the supplier to the recipient of the service.

Under the reverse charge, the supplier does not charge VAT on their invoice for the service supplied. Instead, the recipient of the service in the UK must account for VAT as if they had made the supply themselves, by paying 20% of the value of that cost to HMRC. This involves reporting the VAT on their VAT return, both as output tax (as if they had supplied the service) and as input tax (reflecting the VAT on the purchase), subject to the normal rules of VAT recovery.

The business must then consider whether any or all that VAT is recoverable as input tax using the normal partial exemption rules. As UK financial services businesses often suffer an irrecoverable VAT cost, this reverse charge mechanism can mean that these businesses cannot recover all or some of the VAT paid to HMRC

This mechanism prevents the need for suppliers to register for VAT in every EU member state where they have customers, simplifying international trade within the VAT area. It also ensures that VAT is accounted for in the Member State where the recipient is based, aligning with the principle that VAT should be charged in the location where services are consumed.

The final, important point is that the value of these ‘reverse charge’ services needs to be included in the VAT registration threshold calculation for the UK recipient. So, if a financial services business, which isn’t otherwise required to be registered (as it makes VAT exempt supplies which are not included in the turnover calculation), receives non-UK services, the value of which is over the registration threshold, the business is required to register for UK VAT and pay VAT to HMRC.

Impact on UK businesses

The key things to takeaway are:

• For UK based financial services businesses supplying services: When supplying specified services to a business customer in another country, the UK supplier does not charge VAT. There is a possibility of recovering some or all of the VAT on costs if the services are specified supplies, but the business must still ensure that its VAT reporting practices are compliant.
• For UK based financial services businesses receiving supplies from non-UK suppliers: When receiving supplies from abroad, the business must apply the reverse charge on its VAT return. This means they must account for both the output VAT (as if they had made the supply themselves) and reclaim the input VAT (as per the normal rules), provided they are entitled to recover VAT on their purchases.
• Understand place of supply rules: Businesses should thoroughly understand the place of supply rules to determine the correct VAT treatment for international services.
• Optimise VAT recovery: By structuring transactions and operations efficiently, FS firms can maximise their VAT recovery on both domestic and international costs.
• Compliance and reporting: Compliance with the rules surrounding specified supplies and the reverse charge mechanism requires careful attention to the nature of the supplies, the status of the customer, and the country involved.

Given the complexity and potential impact of specified supplies on VAT liabilities and cash flow, businesses engaged in international trade of services should seek professional advice to navigate these rules effectively. Proper management and compliance can help avoid costly mistakes and penalties while ensuring smooth international transactions.

Contact Dougie Todd, Partner and Co-Head of VAT, for further advice.