VAT, Reverse Charge and Withholding Tax on Offshore Development Invoices

Who charges VAT on an offshore development invoice?

Nobody charges it — you self-account for it. For business-to-business services, the place of supply is where the customer is established, so a development service bought by a German, Dutch or Swedish company from an Indian or UAE vendor is supplied in the customer's country. The vendor invoices without VAT, and the buyer accounts for the VAT due under the reverse charge in its own return.

That single rule resolves most of the confusion procurement teams have when the first offshore invoice arrives with no tax line on it. The invoice is correct. The obligation moved to you.

What does the reverse charge mean in practice?

You declare output VAT at your domestic rate on the value of the service, and in the same return you deduct the corresponding input VAT to the extent you are entitled to recover it. For an ordinary trading company with fully taxable activities, the two entries cancel and the arrangement is cash-neutral, though it still has to be reported correctly.

Three practical points follow. Give the vendor your VAT identification number and make sure it appears on the invoice, so the zero-rating position is evidenced. Make sure the invoice describes a service rather than a licence, for the reason in the next section. And check that your finance system posts the reverse charge automatically, because manual handling of recurring monthly vendor invoices is where errors accumulate quietly.

When is VAT a real cost rather than a bookkeeping entry?

When you cannot fully recover input VAT. Banks, insurers, many payment firms, healthcare providers, education providers and other partly exempt businesses recover input VAT only in proportion to their taxable activities. For them, reverse-charge VAT on a large development contract is an irrecoverable cost that can add a meaningful percentage to the true price of the engagement.

If you sit in one of those sectors, put the irrecoverable proportion into the model before you compare vendors — it changes the ranking between an in-house team, whose salary cost carries no VAT, and an outsourced one. This is exactly the kind of line that gets missed in a first-pass comparison, alongside the items in our checklist of hidden costs in software outsourcing.

Is withholding tax due on payments to an Indian vendor?

Usually not on the European side for a pure service — but the contract wording decides it, and this is where careless drafting creates a bill. Most European countries do not impose withholding tax on ordinary service fees paid abroad. Several do impose withholding tax on royalties and on payments for the granting or transfer of rights. Germany's rules on payments for the use of rights are the best-known example, and they are triggered by the legal character of the payment, not by what the parties call it in a slide.

The distinction that matters for software work:

• A development service. You pay for engineers' time or for a defined deliverable, and the resulting IP is assigned to you outright as part of the service. Generally treated as a service fee.
• A licence. You pay for the right to use software the vendor owns and continues to own. Capable of being characterised as a royalty, with withholding consequences in some jurisdictions.

Because outsourced development contracts almost always include an IP clause, it is worth making that clause a full present assignment of all rights in the work product as part of the service, rather than a licence back from the vendor. That is also what you want commercially — the IP terms we recommend are set out in our guide to GDPR, IP and contracts when outsourcing to India.

On the Indian side, the vendor's own tax position is its concern, not yours, unless the contract contains a gross-up clause. Read that clause carefully: an obligation to gross up for taxes imposed in the vendor's country can quietly transfer a foreign tax cost onto your budget.

What should the contract and invoice actually say?

1. Both VAT numbers or tax registrations on every invoice, with your VAT identification number stated for the reverse charge position.
2. A clear service description — engineering services, deliverables, period covered — not "software licence" or "product".
3. Present assignment of IP in the work product as part of the service, with waiver of moral rights where the law allows.
4. Prices stated exclusive of VAT, with an explicit statement that the reverse charge applies where relevant.
5. A narrow gross-up clause, if any, so that you are not underwriting taxes in the vendor's jurisdiction.
6. Named contracting entity and delivery locations, which your tax team needs in the same way your compliance team does.

Does anything change with a UAE or other non-EU vendor?

The mechanism is the same. The place-of-supply rule for business-to-business services looks at where the customer is established, so a European buyer self-accounts under the reverse charge whether the vendor sits in India, the UAE, the United Kingdom or anywhere else outside its own country. The UAE has its own domestic VAT regime, but a supply of services to a business customer established outside the UAE is generally outside the scope of UAE VAT, so you should not see Emirati VAT on the invoice.

What does change between vendor countries is the double tax treaty position behind any withholding question, and the practical documentation you may be asked for — a certificate of tax residence, for example. Ask the vendor which entity invoices you and in which country it is tax resident before the first invoice, not after.

Invoice problems worth catching early

• VAT charged in error by a vendor unfamiliar with EU rules. Reject and reissue rather than paying and hoping to recover it — you cannot reclaim foreign VAT through your domestic return.
• Missing VAT identification number, which weakens your evidence for the treatment.
• Descriptions such as "software licence" or "product" where the substance is a development service.
• Bundled invoices mixing services, travel and third-party tooling, which complicates both VAT treatment and cost allocation.

What changes if you set up your own entity instead?

Everything, and mostly for the worse in the first year. A vendor relationship is a third-party purchase with a clean invoice. Your own Indian subsidiary is a related party, which brings transfer pricing into scope: intercompany charges must be at arm's length, supported by a documented method — a cost-plus mark-up is the usual approach for a captive development centre — and defensible to two tax authorities rather than one. It also raises the question of whether the activity creates a permanent establishment exposure for the parent, which we cover in permanent establishment and transfer pricing risk when European companies offshore development.

That is not an argument against owning an entity at scale. It is an argument for sequencing: prove the delivery model through a vendor relationship first, and take on the intercompany machinery when the headcount justifies the overhead. The comparison between the two structures, including the employer-of-record middle option, is in our note on employer of record versus outsourcing versus your own entity.

ILMTEC contracts with European companies as a straightforward service provider, with senior India-based engineers embedded in your team and a single clean invoice. See the engineering talent solution for how it is structured.

This is general information about how these rules commonly work, not tax advice. Positions differ by country, sector and contract; confirm yours with your tax adviser before you rely on it.