Reverse Charge VAT for B2B Digital Services Explained

Introduction 

Even before the birth and rapid growth of the digital economy, the VAT rules for cross-border operating businesses were challenging. The understanding of VAT rules for small and medium-sized businesses that operate internationally can be even more difficult, considering the probable lack of resources compared to large enterprises that, in many cases, have even tax sub-departments with a primary focus on VAT requirements for cross-border transactions. 

The place of supply rules, different VAT rules depending on the type of transactions(B2B or B2C), calculation of the registration threshold, VAT rates, accounting rules, invoicing rules, are just some of the requirements that a non-established business needs to review in each jurisdiction where it supplies its respective services. 

Understanding the maze of specific VAT rules, which are typically tailored to the supplies of digital services, introduces many complexities. In this article, we provide clear guidance on the key points for understanding the VAT rules on the supplies of cross-border B2B digital services. 

One of the great benefits of being a digital service provider is the possibility to operate a cross-border business without many challenges and related costs that come with the supply of goods or having a physical presence in more than one jurisdiction. 

VAT rules for the provision of digital services to domestic and foreign customers differ. One of the first questions that digital service providers need to consider is whether they are providing their cross-border digital services to other taxable persons or directly to end customers. 

Place of Supply Rules for Provision of Digital Services 

Currently, more than 130 countries have introduced some type of VAT rules for providers of digital services. For B2C supplies of digital services, the general rule that most countries have incorporated into their domestic law states that the place of supply for cross-border B2C digital services is in the country where the service is based. (destination-based principle) 

When it comes to the place of supply rules for B2B cross-border supplies of digital services, the rule that most jurisdictions have adopted in their national tax provisions states that the place of supply is the place where the business recipient is based. 

VAT rules for cross-border B2B services aren’t unified, meaning that even most of countries follow the OECD guidelines for the place of supply rules and related VAT compliance rules based on the jurisdiction where the business customer is located, some countries have different rules in place when it comes to VAT registration, and other interdependent VAT compliance obligations. 

Reverse Charge Mechanism for B2B cross-border supplies of digital services

Most jurisdictions have incorporated the OECD recommendations concerning the VAT treatment of cross-border supplies of B2B digital services into their domestic VAT regulations. The recommendation states that the place of supply for cross-border B2B digital services is in the jurisdiction where the business customer has its place of business, establishment, or residence, depending on the transaction specifics and where the service is used or acquired. 

When it comes to the VAT accounting rules for the underlying supply, the OECD recommends that for cross-border supplies of digital services, the reverse charge mechanism should be used.  Practically speaking, this means that in the situation where the VAT-registered supplier make a cross-border supply of digital services to another natural or legal person acting as business(mainly VAT registered, but it’s not necessary in all jurisdictions), the buyer that purchase business purposes is required to account for VAT based on reverse charge. 

When this is the situation, the supplier is “free” from the obligation to register for VAT in the country where VAT is due. If the reverse charge mechanism isn’t used, the supplier would most probably be obliged to register for VAT in the country of destination. 

In this case, the business that acquires the digital service for business purposes based on reverse charge, from the VAT responsibility perspective, becomes a supplier. The purchaser is responsible for self-assessment of its VAT duty, as it was the supplier in the concerning transaction. 

The business for the concerned transaction reports VAT through its respective periodic return as output (sales) tax, and in most cases, can also claim input tax credit on the same transaction (reporting it as input tax) on the same return, thereby practically annulling the charged VAT. 

However, the applicability of the reverse charge VAT B2B digital services concept isn’t uniformly adopted by all jurisdictions that have VAT rules for cross-border provision of digital services. There are jurisdictions in which the non-resident supplier of digital services that exclusively makes B2B supplies of digital services is obliged to register for VAT in the country of destination, to be able to later account for this transaction, and report it in the domestic return. 

Accounting for VAT 

As previously mentioned, in most of the jurisdictions that have implemented into their domestic law a taxation of digital services provided by non-resident providers, the OECD’s reverse charge VAT B2B digital services model has been followed. 

In these tax jurisdictions, the VAT accounting and reporting obligation is transferred to the recipient(business person). The VAT-registered customer follows the self-billing procedure, where it “acts” as the supplier of the service. The customer charges and calculates VAT according to the tax rate applicable in the country where they have their place of business. 

Invoicing for B2B digital services 

Invoicing rules are a critical element of the B2B digital services VAT compliance framework. The supplier’s invoice will not include any indication of VAT, as the VAT will be charged and reported by the customer. 

However, the provider of the service is obligated to include a note that the reverse charge applies according to the “precise article of the applicable provision”.  From the suppliers’ reporting perspective, the supply is tax-exempt, and it “provides the benefit” of not being obliged to register for VAT in the country of destination.  

The customer’s VAT number should be included on the invoice, as confirmation that the customer is a VAT-registered person who will carry out the self-assessment of the tax. Validating the customer’s tax number is highly recommended as a precautionary measure to avoid potential tax liabilities associated with cross-border transactions. 

Tax Reporting for B2B digital services

Tax reporting for cross-border B2B digital service transactions depends on the tax provisions that are applicable in the recipient country. In most jurisdictions, for this purpose, the supply will be “tax-exempt” under the principle of a reverse-charge mechanism for the supply. 

The customer, being a VAT-registered business, will have the tax reporting obligation under the self-assessment methodology. The customer will act from the supplier’s perspective when it comes to accounting and reporting for the respective transaction.

It will report output tax in its domestic periodic return. If possible (most often), it will reclaim the input tax credit for the same transaction in the same periodic return. Practically, the output tax for that transaction will be annulled within the same return. 

Specific jurisdictions 

As mentioned above, most jurisdictions that have extended their taxability scope to include the provision of digital services by non-resident providers have modeled their rules on the OECD’s concept. The OECD’s framework states that for cross-border provision of digital services for B2B transactions, the reverse-charge method should be used. 

To “make things” less boring, more than 15 jurisdictions have introduced different rules. Some of them, like the Philippines, require non-resident providers of digital services that register for local VAT and submit periodic returns, even if they provide exclusively B2B transactions. 

The National Bureau of Revenue of the Philippines explains that this return will be informative, enhancing the quality of the monitoring framework for reporting withholding VAT that domestic VAT-registered businesses are required to report for these transactions. 

How to Stay Compliant 

The VAT requirements for cross-border operating non-resident digital service providers are continuously evolving. Most jurisdictions have focused their attention on B2C transactions and related VAT compliance responsibilities, leaving the VAT reporting duty for B2B transactions to the businessperson. 

However, many jurisdictions have chosen to introduce particular rules for the cross-border B2B digital services VAT compliance. 

Our onboarding team has gained significant experience providing top-notch VAT registration assistance for non-resident suppliers of digital services.  With a high degree of specialization in the e-commerce and digital economy tax world, we look forward to assisting clients who seek to expand their reach into various jurisdictions.