Many entrepreneurs, particularly owners of small businesses, have questions about the reverse charge mechanism for services. This occurs when the obligation to calculate and pay VAT shifts from the seller to the buyer of the service. This article clearly explains how reverse charge for services works in Estonia and how to correctly report it in the KMD declaration.
What is Reverse Charge on Services?
Reverse charge is a mechanism where the buyer of a service calculates and declares Value Added Tax (VAT) themselves instead of the seller. This situation most commonly arises when purchasing services from foreign companies. The standard VAT rate in Estonia is 22%.
When is Reverse Charge Applied?
Reverse charge applies when:
- You purchase a service from a foreign company (within the EU or outside the EU);
- Your company is registered as a VAT payer in Estonia;
- The service is actually used in Estonia.
Example: Your company orders website design from a Latvian company. The Latvian company issues an invoice without VAT, indicating "reverse charge." In this scenario, your company must calculate and declare the 22% VAT itself.
How to Report Reverse Charge in the KMD Declaration?
Small businesses are often surprised to see the amount subject to reverse charge reflected not only in row 6 of the KMD declaration but also in row 1. This leads to the question, "Why did the accountant put it in row 1 if these aren't our sales?" However, this is correct:
- Row 6 ("Services purchased from a VAT payer from another EU country") shows the net amount of the service without VAT. For example, €1,000 for website design.
- Row 1 ("Taxable turnover") will also show €1,000, even though it is not your sales income. This legal requirement allows the tax authority to confirm you have calculated the VAT yourself.
The reverse charge VAT of 22% (€220 on €1,000) is simultaneously reported as both payable VAT and deductible VAT. Therefore, the net VAT due is zero.
If the purchase is from a foreign company outside the European Union, the situation is similar, but you should use row 7 instead of row 6.
NB! There are exceptions to this rule concerning specific goods taxation nuances. You can read more about this in our dedicated article on the subject.
When Does Reverse Charge Not Apply?
It is important to understand that within Estonia, reverse charge is applied only in specific cases (such as purchasing scrap metal or certain metals). Typically, if you purchase services from an Estonian company, you will receive a regular invoice including the standard VAT rate of 22%. Primarily, reverse charge affects purchases from foreign companies.
Legal Basis
The primary document governing reverse charge in Estonia is the Value Added Tax Act (Käibemaksuseadus). Key sections related to reverse charge include §10, §37, and §41¹.
Summary
Reverse charge on services is mandatory for small businesses purchasing services from foreign companies.
Key points to remember:
- The service amount is reported in both row 6 and row 1 of the KMD declaration;
- The net reverse VAT payable usually totals zero;
- Even if you have no sales, the amount in row 1 of the KMD declaration will reflect purchases from foreign companies.