The way VAT is being collected in the building and construction industry is changing from 1st March 2021. The domestic reverse VAT charge for construction is effectively an extension of the Construction Industry Scheme (CIS) and applies only to transactions between VAT-registered and CIS-registered contractors and sub-contractors.
The introduction of the domestic reverse charge was planned for 1st October 2020, but this has been delayed due to the impact of the coronavirus pandemic on the construction sector.
What is a reverse VAT charge?
In broad terms, a reverse VAT charge means that the customer receiving the service will pay the VAT to HMRC instead of to the supplier or sub-contractor. HMRC aims for the new reverse VAT charge rules to help combat VAT fraud, by moving the VAT payment to the end of the supply chain.
Who will the reverse VAT charge affect?
The new domestic reverse VAT charge will apply to you only if you are a VAT-registered and CIS-registered business, supplying certain construction services to another VAT-registered and CIS-registered business for onward sale. These ‘specified services’ are generally services that are defined as construction operations for purposes of the Construction Industry Scheme (CIS). If you are VAT-registered and have CIS tax deducted, then this new legislation is likely to affect you.
It’s important to note:
- The reverse VAT charge does not apply if the supply consists only of materials.
- If there is a reverse charge element in a supply, then the whole supply will be subject to the domestic reverse charge.
- The reverse VAT charge applies to both standard and reduced rate VAT.
This new way of accounting for VAT will be introduced without any transitional period and will have a significant impact on the accounting practices and cash flow of businesses in the construction sector.
How will the reverse VAT charge work?
When the conditions for the reverse VAT charge apply, VAT will be calculated as a paper exercise and registered on the invoice as a ‘reverse VAT charge’. It will be the responsibility of the ‘end user’ – at the top of the supply chain – to then pay the tax.
A supplier or sub-contractor will issue a VAT invoice, but invoicing only for the cost of their services, rather than for the cost of their services plus VAT. Instead, the invoice will state that the service provided is subject to the domestic reverse VAT charge, and therefore the invoice recipient must pay or account for the VAT to HMRC.
The invoice recipient must then include the VAT due on that supply on their VAT return, instead of paying the VAT to the supplier. The recipient may recover that VAT amount as input tax, subject to the normal rules.
Sam is a sub-contractor and has provided £1,000 of electrical installation services on a construction site. He has been working for Colin, the contractor. Sam and Colin are both VAT-registered and CIS-registered and the service provided falls under the ‘specified services’ – therefore the reverse VAT charge applies.
Sam invoices Colin for £1,000 (excluding VAT) and makes sure that the invoice states: Reverse charge: Customer to pay the VAT to HMRC.
Colin pays Sam £1,000, and must now account for the £200 VAT due on Sam’s services on his own tax return to HMRC.
Reverse VAT charges and supply chains
Where there is a supply chain, the supplier receiving payment from the end customer, or end user, will be responsible for paying the VAT.
The Government has estimated this will impact up to 150,000 construction-sector businesses and admits that the administrative burden is likely to be significant. While the new reverse VAT charge rules won’t change a company’s net or gross profits, businesses will need to consider the potential impact on their cash flow.
Using our example above: under the current rules, sub-contractor Sam would invoice for and receive £200 VAT from contractor Colin. This £200 would be useful working capital for Sam, until he then pays his VAT to HMRC. Under the reverse VAT charges, Sam will no longer invoice Colin for the VAT, and will lose this potential working capital.
The official guidance is that the reverse charge will not apply to all contractors, only applying to ‘specified services’. However, the definition of these services mirrors those services defined as “construction operations” in the ‘Construction Act’. Therefore, it will affect most construction companies to some extent.
What do you need to do now?
We recommend that sub-contractors and service providers consider moving to a monthly VAT return, in order to help to negate the negative cash flow implications of no longer receiving VAT on their sales invoices. This will be particularly helpful for businesses making a net claim rather than a net payment on their VAT return.
- Review supplies made to and received from other VAT-registered contractors to establish where these will be subject to reverse VAT charges from October 2019. If you’re unsure, HMRC has produced a helpful flow chart.
- Obtain notification from customers that they are an end user.
- Obtain confirmation of customers’ VAT registration and CIS status.
- Consider any adaptions required to ensure accounting systems can deal with this change, and make sure that those responsible for VAT accounting are familiar with the new rules.
- Consider the impact on cash flow from October 2019 and if there are any other ways to mitigate this.
- If you want to find out about the reverse VAT charge in more detail, you can sign up to this webinar from HMRC or take a look at their online guidance.
How can we help you?
You might find it easiest to get in touch with your accountant to discuss the new rules, the implications for your business and how best you can mitigate the potential impact. Hamish and the team at Crunchers Edinburgh are happy to answer any questions you may have, and to discuss the potential impact of the new reverse VAT charge rules on your business.
With many years’ experience – including providing support to large businesses and organisations, including Siemens, Barclays and the Scottish Government – Crunchers Edinburgh now specialises in using this know-how and trusted expertise to help small businesses grow to their full potential. Get in touch with us to see how we can help you!