Recovery of VAT incurred on digital services prior to VAT registration

We receive many queries regarding the charging of VAT on supplies of digital services supplied by overseas suppliers to UK businesses before they register for VAT and whether that VAT can be recovered as input tax once the UK business registers for VAT; queries such as:

“My client is a Limited Company and was trading before having to register for VAT when their turnover exceeded the registration threshold 

My client receives supplies of digital services from suppliers outside the UK and prior to their VAT registration incurred UK VAT at 20% on these supplies but since my client has registered for VAT and provided the supplier with their UK VAT registration number, the supplier is no longer charging my client UK VAT. Is this correct and if so, can my client claim the VAT they incurred on these supplies to them prior to their VAT registration?”

The answer depends upon a fundamental rule of input tax in that VAT is only input tax within its definition in the VAT Act if it is correctly charged; if not, it is not input tax and is not recoverable, whether incurred prior to or after VAT registration.

So, the real question here is whether, VAT charged on supplies of digital services by an overseas supplier to a UK business that is not registered for VAT in the UK is correctly charged by the supplier?

The answer to that question depends upon whether the overseas supplier is, at the time the supply is made by them, treating the supply as being to a UK based business, so the supply is Business to Business (B2B), or a UK based non-business consumer, so the supply is Business to Consumer (B2C),

In both cases the supply by the overseas supplier is subject to UK VAT.

However, where the supply is B2B, the overseas supplier is not required to charge UK VAT and instead the UK business recipient deals with the UK VAT using the reverse charge procedure but, if the supply is B2C, it is the overseas supplier that is responsible to charge and account for the UK VAT.

In the VAT Notice 741A, HMRC suggests that if a UK supplier is supplying certain services, including digital services, to another business based outside the UK, the UK supplier should not charge VAT if they are satisfied that the customer is a business and holds evidence to demonstrate that.

It is generally understood that this applies in the opposite direction, where the supplier is based outside the UK and the recipient of the service is a business based in the UK.

That guidance also suggests that the evidence referred to would normally be the customers VAT registration number but that, if the customer is not registered for VAT, HMRC advises that the supplier can accept other commercial evidence to demonstrate that the customer is a business.

The issue is the use of the word “can” in HMRC’s guidance on accepting other commercial evidence of the customer being a business, as the use of that word appears to provide the supplier with a choice as to whether to accept other evidence or only accept a VAT number as evidence.

This also seems to have been enforced by other, more simplified, guidance issued by HMRC in regard to suppliers of digital services made to UK customer by overseas suppliers which, in its more simplified wording, appeared to suggest that an overseas supplier should only accept a VAT registration as evidence of the customer being a business.

Therefore, on that basis, some overseas suppliers of digital services have adopted the policy of only accepting a UK VAT registration as proof of the customer being a business in the UK whilst others choose to accept other evidence.

Given the guidance, both approaches must therefore be considered to be correct and so, where an overseas supplier that has chosen not to accept any other evidence other than a VAT registration number makes a supply to a business that is not registered for VAT in the UK, the supplier will treat the supply as B2C and so has a requirement to themselves register for VAT in the UK and charge and account for UK VAT on the supplies to UK customers that have provided no VAT registration number.

Therefore, assuming the overseas supplier provided a proper tax invoice showing their UK VAT registration number and charging UK VAT, the VAT is correctly charged, thus meeting the definition of input tax and so is claimable; subject of course to the general rules for recovering VAT on services received prior to VAT registration.

Of course, as is the case with the client in the example query, if an overseas supplier made supplies to a UK business that at some point registers for VAT and that UK business provides them with their UK VAT number, the overseas supplier would change to treating all subsequent supplies as B2B, stop charging UK VAT and instead the UK business recipient must treat the supply to them under the reverse charge.