VAT on outsourced services: the reverse charge explained

Key takeaways

VAT on outsourced services changes the in-house vs outsourcing comparison for some UK businesses. Salaries carry no VAT; outsourced services usually do. Overseas providers do not charge UK VAT, but the reverse charge makes the UK customer account for it. VAT-exempt and partly exempt businesses may not recover it, which adds up to 20% to the cost.

• 20% is the standard VAT rate a UK provider usually adds to its invoice.
• Overseas providers: the UK customer accounts for VAT under the reverse charge.
• Unregistered businesses: reverse-charge services count towards the £90,000 threshold.
• Exempt businesses such as some insurance and health firms may not recover the VAT.

Do outsourced services carry VAT?

Usually. A VAT-registered UK provider charges VAT at the standard rate of 20% on most business services. An overseas provider does not charge UK VAT, but under the general rule for business-to-business services, the supply takes place where the customer belongs, so the UK customer accounts for VAT through the reverse charge. Employee salaries carry no VAT at all.

• In-house vs outsourcing: which model is more cost-effective?

How does the reverse charge work?

Under the reverse charge, a UK business receiving services from an overseas supplier acts as both supplier and recipient for VAT. It records output VAT on the value of the service and, subject to the normal rules, claims the same amount back as input VAT on the same return. For a fully taxable business, the net effect is usually nil.

• Outsourcing to Sri Lanka from the UK

Can the reverse charge force VAT registration?

Yes. HMRC guidance says that an unregistered UK business must add the value of general rule services received from overseas suppliers to its taxable supplies when checking the VAT registration threshold, currently £90,000. A small business outsourcing heavily offshore could cross the threshold even with low sales. Check before signing.

Why does VAT matter more for exempt businesses?

Businesses whose own sales are VAT-exempt, such as many insurance brokers, financial services firms and some healthcare providers, cannot fully recover input VAT. For them, VAT on a UK provider's invoice, or reverse-charged VAT on an overseas provider, is a real cost. Comparing a £12 outsourced rate with in-house staff, they should use £14.40 if VAT is irrecoverable.

• Admin outsourcing for mortgage brokers
• Admin and reception outsourcing for UK clinics

How should VAT change your comparison?

If you are fully taxable and VAT-registered, compare outsourced costs net of VAT, because you recover it. If you are exempt or partly exempt, add the irrecoverable share of VAT to the outsourced cost. If you are unregistered, check the threshold effect of reverse-charge services.

• In-house vs outsourcing cost calculator: a worked template

Does VAT make outsourcing not worth it for exempt firms?

Not usually. A 20% uplift on a £9–£18 offshore rate still leaves most repeatable work cheaper than a loaded UK employee at £16.27 or more per worked hour before overheads. But the margin narrows, so exempt firms should run the comparison with VAT included. This is general information; take advice from your accountant.

• BPO Solutions for UK businesses

How does VAT affect the cost comparison in pounds?

For a fully VAT-exempt business, irrecoverable VAT raises an outsourced rate by 20%. On the 1,400-hour admin example used across this series, £12–£15 per hour becomes £14.40–£18 per hour, and the outsourced total rises from about £18,900–£23,100 to about £22,200–£27,300 a year, against about £39,300 in-house. Outsourcing still saves money, but less.

• In-house vs outsourcing: which model is more cost-effective?

What does this look like in practice?

A pattern we see with UK brokerages: the first comparison ignores VAT. Adding irrecoverable reverse-charged VAT to the offshore rate reduces the saving, but moving document chasing off advisers still pays clearly, because advisers' time is worth far more than the VAT-inclusive rate.

• See client work

VAT checklist

Check these with your accountant.

• Is the provider in the UK or overseas?
• Are you VAT-registered, and fully taxable?
• What share of input VAT can you recover?
• Could reverse-charge services push you over the threshold?
• Is VAT included in your cost comparison?

Next step

Tell us your VAT position and the work you plan to outsource. We will include VAT in the cost comparison in a 30-minute call, alongside your accountant's advice.