Dear Contractor Doctor
I’ve just started working on a six-month IT contract for a software firm in Dublin. I spend about half my time onsite with the client, and the rest working from my home office in the UK.
My limited company operates the VAT Flat Rate Scheme (FRS) and when I spoke to the client about billing arrangements, they were adamant that I should not include VAT in my invoice. But if I’m paying 14.5% of my total invoice value to HMRC, as required by the FRC, I’ll end up significantly out of pocket.
How does the VAT Flat Rate Scheme work when I invoice an EU client?
Contractor Doctor says:
“From January 2010, HMRC introduced new place of supply rules which mean that the general rule for UK-based businesses supplying services to another business outside the UK do not charge VAT,” explains James Abbott, owner and head of tax at contractor accountant Abbott Moore.
“Services supplied to a European Union (EU) client are treated as ‘outside the scope’ of VAT, so a contractor would not include the fees for this work on the VAT return. Fees earned working for EU clients don’t contribute to the invoice total for FRS.”
FRS – why contractors might worry about billing foreign clients
Abbott continues: “For the vast majority of contractors, operating the VAT FRS is quite straightforward; in fact, simplicity is the whole point of the scheme. The contractor invoices their UK client £500, plus £100 VAT at 20%, receiving total payment of £600.
“The FRS percentage for Computer and IT consultancy or data processing contractors would normally be 14.5% [correct at the time of writing], so the contractor would pay over 14.5% of the total invoice value to HMRC as VAT, which equals £87 see VAT Notice 733..”
However, an Irish business client will not be expecting to have a VAT element included in the invoice from a UK supplier. In theory, the Irish business should ‘reverse charge’ the VAT payment to the Irish Revenue, as a result of the rule change on 1 January 2010, which was clarified in HMRC’s
“To simplify their VAT affairs, a contractor could choose to leave the FRS but, having left, they cannot rejoin for a period of 12 months,” highlights Abbott. “A contractor could also deregister completely, as long as their vatable turnover does not exceed the threshold. However, the contractor should consider the likely length of the overseas contract before deciding to change their VAT status.”
Place of supply rules puts fees from EU clients ‘out of scope’
“The 2010 rule clarifies that VAT is charged according to the ‘place of supply’,” says Abbott. “So, in Janis’s situation, she is delivering services to the client in Ireland. VAT rules say that such a transaction is effectively between an Irish supplier supplying an Irish client, making it ‘outside the scope’ and not subject to UK tax.”
Services supplied to a European Union (EU) client are treated as 'outside the scope' of VAT, so a contractor would not include the fees for this work on the VAT return
James Abbott, Abbott Moore
Even though the contractor’s company is based in the UK, because the place of supply is where the client is based, the quirk of UK VAT legislation treats the contractor as if they were a local supplier.
“Transactions that are ‘out of scope’ of UK VAT do not have to be recorded on a contractor’s limited company VAT return, nor do they form part of the contractor’s turnover for FRS purposes. However, they do need to be included as company income for corporation tax purposes,” adds Abbott.
So, using the original example above, the contractor would bill their EU client £500, with no VAT included. And on their VAT return, as they would only include vatable turnover, the £500 received from the Dublin-based EU client would not be included.
Understanding ‘out of scope’, versus ‘zero rated’ and ‘exempt’
‘Out of scope’ for VAT is not the same as ‘zero rated’ for VAT or ‘exempt’ of VAT, Abbott warns. This can cause confusion if these different classes occur in the same transaction. Abbott explains:
- “Zero rated means VAT applies but the rate is zero. This applies to products such as books, some food and children’s clothes
- Exempt means the product or service is specifically exempt from VAT in legislation. Most financial services are exempt, for example
- Out of scope means the transaction is simply not a UK transaction, nor recognised as such by UK VAT rules and HMRC. Out of scope services might include supplying products and services to EU business clients . ”
Abbott adds: “It is technically possible for contractors to qualify for all three, if they are delivering financial services, selling zero rated products such as professional handbooks and providing services to EU-based business clients.”
Transactions outside the EU and exceptions
The above rules cover the sales of services to EU businesses. The rules for selling goods outside the UK are different to those of services. Furthermore, there are exceptions to general place of supply rules for certain types of services, such as those relating to land or entertainment services.
However, the good news is that similar rules exist for selling services to clients outside of the EU as to those outside of the UK but within the EU.
Abbott highlights that the key for contractors us to understand whether their type of service is an exception to the place of supply rules and, if the client is inside the EU, then it’s a business customer, normally by making a note of its VAT number.
Treatment of expenses for VAT and corporation tax
The VAT on expenses incurred outside the UK whilst servicing an EU client cannot normally be claimed. But according to Abbott, the expenses, including the local VAT equivalent, can be claimed in full as a deduction against corporation tax.
This is assuming they fulfil the usual criteria of being wholly and exclusively incurred in connection with the company’s trade.
Abbott concludes: “Limited company contractors using the VAT FRS can charge fees to EU clients exclusive of VAT, because they are out of scope. They only charge VAT FRS percentage rates on the fees earned on vatable and exempt income, so just because the supply is outside the scope they are not out of pocket.”