How can businesses in the construction industry get set for the VAT reverse charge?

1st October 2019

If you operate a VAT registered business within the building and construction industry, you will likely have heard about the ‘Domestic Reverse Charge’ which will change the way VAT is to be collected. Initially, the new legislation was due to be implemented from 1st October 2019 however, due to a lack of guidance from HMRC, pressure from industry experts, and more recently the impact of the coronavirus, the implementation has now been delayed until March 2021.

Man using saw

The changes would have caused major cash flow issues for suppliers and sub-contractors had they not been fully up to speed with the new regulations so the delay provides a welcome extension. The changes are still due to come into force in March 2021, therefore it is important for businesses to assess how the changes will affect them to ensure they are fully prepared.

What are the changes?

Currently, when a VAT registered contractor or subcontractor carries out work, they will invoice the customer the cost of the work carried out, plus the respective VAT, then pay the VAT on to HMRC. If the customer is also VAT registered, they are able to claim back the VAT that they have paid. 

However, under the domestic reverse charge rules, the customer will pay the VAT directly to HMRC rather than paying to the supplier, but can still recover the VAT paid to HMRC as input tax, if applicable.

The new legislation applies to services subject to standard rate or reduced rate VAT provided to VAT registered businesses or individuals in the UK, however zero rated supplies are not affected.

Who is affected?

The new legislation will affect individuals or businesses who are registered for VAT in the UK and supplying or receiving certain services that are reported under the Construction Industry Scheme (“CIS”).

The reverse charge does not apply to:

  • Consumers or final customers (these can be other businesses) as they are not making an onward supply of the building and construction services in question.
  • VAT & CIS registered traders that are connected or linked to the ‘end user’ (either by sharing a relevant interest in the same land or are part of the same corporate group or undertaking)
  • Employment agencies as these organisations supply labour, not the construction services themselves.

How does it work?

Essentially, the new rules mean the customer accounts for the VAT due to HMRC instead of the supplier. However, the supplier still has a responsibility in determining if the services are subject to the reverse charge and if the customer is registered for VAT and CIS. The supplier also needs to determine whether the customer is an end user or intermediary, with the answer to be documented for compliance purposes, as this will also affect if the domestic reverse charge rules apply.

What are the implications of the domestic reverse charge?

For suppliers, the introduction of the domestic reverse charge may have a negative effect on cash flow as they will no longer receive the VAT from the customer, which they could theoretically have in their bank account for up to three months before having to pay it over to HMRC. Consequently, it may have a positive effect on a customer’s cash flow and they will not have to pay the VAT until their next return is due.

Practical steps to prepare for the domestic reverse charge

As a starting point, you need to check whether the domestic reverse charge affects your sales and/or your purchases. If so, you need to consider what impact this will have on your cash flow to plan accordingly once the new rules come into force. For some, notably suppliers who fundamentally supply services that will be subject to the reverse charge rules, switching to monthly VAT returns could minimise the detrimental impact on cash flow. This is because any VAT incurred on costs can be reclaimed much sooner if submitting returns monthly rather than quarterly.

For contractors, take the time to review contracts with your sub-contractors to determine if the services you receive will be subject to the new rules and then notify the affected sub-contractors. It’s important to be vigilant when checking invoices once the new rules come into force to ensure that you are not incorrectly charged VAT on the supplies subject to the domestic reverse charge rules. If you incorrectly pay the VAT to the supplier, you can only reclaim this from the said supplier, not from HMRC.

If you are a sub-contractor, make sure you review your contracts with your contractors and get confirmation from them if the domestic reverse charge applies. Ensure that you obtain written evidence of this – an e-mail will suffice. It is also necessary to confirm with your contractors if they are an end user or intermediary connected with an end user. If so, the domestic reverse charge rules do not apply and the supplies in this case should be invoiced under the current VAT rules.

Finally, make sure that you download any available updates to your accounting system to ensure you have the relevant software in place to deal with the new domestic reverse charge rules and inform all staff who are responsible for VAT accounting about the changes and engage in training if necessary.

If you are unsure if you will be affected by the domestic reverse charge, or have any queries in relation to the changes, please contact Neil Allcroft or Jess Mason on 01926 422292.