VAT Reverse Charge
The VAT reverse charge is a major change in how VAT will be collected, especially in the Construction and building industry. The reverse charge came into effect on 1 March 2021 and will, in many instances, require customers receiving building and construction services to pay the VAT due directly to HMRC, instead of paying the supplier.
Background
The reverse charge is intended to prevent the avoidance of VAT by suppliers who charge and collect VAT from the recipient of a supply but fail to account for that VAT to HMRC (missing trader fraud). The reverse charge shifts the VAT accounting responsibility from the supplier to the recipient. This means those supplying construction services to a VAT registered customer do not have to account for VAT.
It is effectively an extension of the Construction Industry Scheme (CIS) and only applies to transactions that are reported under the CIS and between contractors and sub-contractors.
Services that are affected by the reverse charge
The reverse charge will affect standard-rated supplies of building and construction services - note; not zero-rated supplies - that also fall within the ambit of the Construction Industry Scheme (CIS). Broadly, these services include:
constructing, altering, repairing, extending, demolishing, and dismantling buildings and structures.
constructing, altering, repairing, extending, demolishing, and dismantling works forming part of the land.
pipelines, reservoirs, water mains, sewers, coast protection, or defence.
installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply, or fire protection; and
painting or decorating the internal or external surfaces of any building or structure
Other services not on the list above which are supplied at the same time as these construction services can also be subject to the reverse charge, where those non-construction services are ancillary to the construction services or if the parties elect for the reverse charge to apply to those non-construction services.
What does this mean for companies?
Every construction company needs to ensure that its invoicing and accounting systems are up to speed with the new legislation so they can process supplies covered by the VAT reverse charge. As the VAT amount still needs to be shown on invoices, we expect that many suppliers will mistakenly account for the VAT to HMRC.
Sub-contractors must understand whether they are working for a VAT-registered company and whether they are working for a business within CIS that is not an end client (developer, landlord, tenant, etc).
Some sub-contractors may suffer in cashflow terms if they have been using the VAT from customers as working capital. Our advice is to calculate what the new rules mean to you and then to adjust your procedures and payment terms to mitigate the loss in revenue.
There are some important steps that every construction business should take before they send out their March invoices:
Determine which jobs for VAT-registered companies will fall under the VAT reverse charge from 1 March 2021
Where necessary, gain written confirmation from customers their VAT and CIS status and whether or not they are end clients
Review and update accounting procedures
Calculate the loss of cash flow and review payment terms
If possible, move to monthly VAT returns
If you fall under the VAT reverse charge, come off the Cash Accounting Scheme
If you’re on the flat-rate scheme, check that it is still right for your business
Consider asking suppliers to purchase materials on jobs covered by the VAT reverse charge to lower your exposure to VAT payments.
Working Example
Your company is VAT registered and supplies services to a construction firm (VAT registered) that is building a new housing development for a property developer (VAT registered) who is the customer/end-user.
Under the old VAT rules, you would invoice the construction firm for £60,000 (£50,000 bill for materials and labour plus £10,000 VAT).
From March 1, 2021, your invoice now says £50,000 and states that the VAT reverse charge applies. The construction firm pays him the net £50,000 fee and then accounts for output and input VAT of £10,000 on their VAT return.
Because you do not account for output VAT in your accounts, you receive £10,000 less under the new system. However, you do not have to account to HMRC for any output tax on the transaction.
So although your cash flow has reduced, the construction firm has gained as they do not have to pay you £10,000. However, at the end of its VAT quarter, it cannot reclaim the £10,000 as it is accounting for the reverse charge and the output VAT offsets the input VAT.
How to claim
The reverse charge will not apply where the customer is an end-user; a person who will use the construction services received for its business purposes who has notified the supplier of its status as such.
Businesses that rely on VAT collected from customers as working capital may suffer cash flow problems once the reverse charge is implemented since they will no longer be collecting VAT and be able to use that as a cash buffer until accounting for it to HMRC.
Where the reverse charge does apply, suppliers will now be required to make a note on their VAT invoices that it is their customer that is required to account for the VAT to HMRC.
If the VAT treatment adopted by the parties is later found to be incorrect - for example, because the customer is an end-user but parties nonetheless apply the reverse charge incorrectly - HMRC will expect the customer to notify the supplier that it is an end-user and request a corrected invoice.
We understand that HMRC will not be prepared to offset amounts accounted to it by the wrong parties so, if the reverse charge is not applied where it should be, the customer will have to account for the VAT to HMRC despite having already paid it to the supplier, and will then be required to separately pursue the supplier for a refund.
However, if the property developer sells the partly-constructed property to an investor - with the investor also engaging the property developer to complete the construction of the shed - the property developer will cease to be an end-user and the reverse charge will start to apply to all future payments made by the property developer to its builder.
