Reverse Charge – Shifting VAT Liability under Italian Tax Law

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HOW REVERSE CHARGE WORKS

_{Note: document translated from German; images not translated.}

Wikipedia: “…the supplier must pay the VAT to the tax authorities and the recipient of the service may deduct the VAT paid as input tax. Under the reverse charge mechanism, however, for certain transactions the VAT liability is shifted to the recipient.”

The application of the reverse charge mechanism – in German also referred to as “Steuerschuldumkehrung”, in Italian “sistema di inversione contabile” – works in practice as follows.

A supplier issues, for the supply of goods or the provision of services, an invoice without VAT. This invoice is then supplemented by the customer, who must also be a business, upon receipt. In practice, this means that the customer notes the VAT on the invoice manually or, nowadays, also by means of accounting software.

The special feature of the procedure does not end there: unlike normal purchase invoices issued with VAT, the customer is required to record this invoice not only in the purchase invoice register, but also in the sales invoice register. This means that, for the customer, input VAT and output VAT neutralize each other. The same naturally applies to the supplier, since the supplier has already issued the invoice without VAT.

An example may help to illustrate the procedure:

An Italian company receives the following invoice from an EU supplier:

1[3]

The company supplements the invoice with VAT, which in Italy amounts to 22%:

2[3]

The Italian company records the invoice in the purchase invoice register:

No.	Supplier/Customer	Description	Taxable amount	VAT	Total
1	Test GmbH	Intra-Community acquisition	1,000 €	220 €	1,220 €

The invoice is then also recorded in the corresponding sales invoice register. Modern accounting programs generate this entry automatically, meaning that the invoice is effectively posted only once. The numbering is identical in both registers.

No.	Supplier/Customer	Description	Taxable amount	VAT	Total
1	Test GmbH	Intra-Community acquisition	1,000 €	220 €	1,220 €

The recording of the invoice in the VAT registers also results in the automatic accounting entry of the transaction in the general ledger under double-entry bookkeeping. The following accounts are affected:

Debit account	Amount	Credit account	Amount
Purchase of goods	1,000 €	Trade payables	1,000 €
Input VAT	220 €	Output VAT	220 €

As can be seen, the VAT credit and the VAT liability offset each other; what remains is therefore a purchase of goods and a liability towards the supplier amounting to 1,000 €.

In addition, the Italian customer is required to submit the “communication of foreign invoices”, also known as the “comunicazione delle operazioni transfrontaliere / esterometro”, and possibly also an Intrastat declaration. Whether the foreign supplier must also submit an Intrastat declaration naturally depends on the provisions applicable in its country of establishment.

ORIGIN OF THE PROCEDURE

The main area of application of the reverse charge mechanism concerns cross-border supplies of goods and services. Since 1985, the European Union has been working unsuccessfully on the so-called clearing system, the introduction of which would make it possible to deduct the VAT of foreign suppliers in the same way as that of domestic suppliers. As long as this is not the case, the reverse charge mechanism applies.

A further reason for the extended application of reverse charge since 2007 lies in the alleged fight against VAT evasion in certain “risk sectors”, such as construction and related activities. In these sectors, there are said to be companies that issue invoices with VAT but then fail to pay it. However, the broader application of the procedure produces, intentionally or unintentionally, significant collateral effects. Companies that are predominantly subject to reverse charge, and therefore issue invoices without VAT, in fact generate a permanent VAT credit, since they make numerous purchases with VAT.

In general, the reverse charge mechanism leaves a slightly bitter aftertaste. What sense does it make to first supplement an invoice with VAT, then record it in two registers, merely in order to offset that VAT? The same result could be achieved simply by leaving the invoice as received from the foreign supplier and recording it without VAT, as is also possible, for example, for invoices exempt from VAT.

LEGAL REFERENCES

With regard to the application of the reverse charge mechanism, reference must be made to the Italian VAT Law, Presidential Decree 633/1972, in particular the territoriality provisions set out in Articles 7 to 7-octies and the operational provisions set out in Article 17. In addition, Decree-Law 331/1993, which regulates intra-Community transactions in detail, must also be taken into account.

ELECTRONIC INVOICING

The introduction of mandatory electronic invoicing from 2019 has so far had only limited effects on the application of the reverse charge mechanism. For external reverse charge pursuant to Article 46 of Decree-Law 331/1993, nothing changes, since foreign parties will continue to issue invoices in paper form or, in any case, according to the rules of their own country. For invoices from EU Member States that have meanwhile also introduced electronic invoicing, and for domestic reverse charge, in addition to the manual integration of the printed invoice, it is now also possible to prepare an electronic integration document (TD17, TD18 or TD19), which automatically generates the accounting entry and therefore saves a considerable amount of work and storage space.

MAIN AREAS OF APPLICATION AND PRACTICAL CASES

In order for the reverse charge mechanism to apply at all, the transaction must be a so-called B2B transaction. This means that the customer must always be an entrepreneur or, in any case, a person holding a VAT number. It can therefore never be a private individual.

The following areas are most frequently affected by the application of reverse charge:

Intra-Community supplies and services

An Italian furniture retailer purchases furniture from its supplier in Germany.

	Subcontracting agreements Example: a construction company assigns plastering work to a subcontractor.
	Installation of systems Example: an electrician installs electrical systems in a company building.
	Completion works Example: painting work.
	Demolition works Example: demolition and reconstruction of a building.
	Building cleaning services Example: cleaning the windows of a glass façade.
	Trade in electronic products Example: sale of smartphones.

DIRECT VAT IDENTIFICATION IN ITALY FOR THE APPLICATION OF THE REVERSE CHARGE MECHANISM

As a general rule, companies are not necessarily required to identify themselves for VAT purposes in Italy merely because they carry out an activity in Italy. However, circumstances may arise that make registration necessary, including the application of the reverse charge mechanism. Only those who have a VAT position in Italy can apply this procedure in Italy. For example, the performance of construction work by a German entrepreneur for a customer in Italy does not, in itself, trigger an obligation of direct VAT identification. However, if that entrepreneur employs German subcontractors on the Italian construction site, VAT identification becomes necessary in order to apply the Italian reverse charge mechanism to the relevant invoices.

CONCLUSION

The complex reverse charge mechanism was originally conceived as a supposed transitional solution to avoid the formation of VAT credits in cross-border exchanges of goods and services, but it is increasingly also used to combat tax evasion. This increases the complexity of accounting and often leads to the formation of VAT credits. We remain at your disposal for a review of your specific case.

Author: Patrick Moling, chartered accountant		For enquiries, please contact: Hermann A. Graber, chartered accountant - 0039/0474/572900 or info@graber-partner.com

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