On the 1st March this year, the UK VAT ‘reverse charge’ will apply to VAT-registered businesses in the Construction Industry Scheme (CIS). Designed to combat VAT fraud in the building and construction sector, the move will heavily impact VAT compliance and company cashflow.
Originally expected on the 1st October 2019 the measure was delayed until the 1st October 2020 due to fears around business preparedness. The coronavirus pandemic and Brexit further extended the latest delay to March 2021.
Essentially it means that the end-customer purchasing construction services or materials must account for the related VAT themselves, instead of the supplier. The VAT is paid directly to HMRC, so relieving supplier liability.
Remember that the VAT reverse charge only applies to UK companies carrying out construction services in the UK.
What are the key conditions?
The reverse charge will apply right through the supply chain until a customer receiving the service or materials is no longer related to construction.
The reverse charge should be applied when all the following conditions are met:
VAT-eligible construction services and/or materials have been supplied to an end customer in the UK.
The customer and the supplier are not connected or linked.
The VAT rate applied is either the standard or reduced rate.
Both the supplier and the customer are VAT and CIS registered.
Why have the measures been introduced?
VAT fraud costs the UK Exchequer more than £100 million a year. Unfortunately, this fraud is often carried out by organised criminals in the construction sector, attracted by the chance of 5% or 20% extra (illegal) profit.
Historically, unscrupulous business owners have charged VAT to supply a particular service before later failing to pay their VAT bill. The effect of the VAT reverse charge is that VAT payment is moved down the supply chain, making this type of fraud near impossible.
Reverse charge schemes are not new – they’re just new to the construction sector. Similar ones have already been introduced for businesses like computer chip retailers, wholesale energy suppliers and mobile phone sellers.
Which services will come under the VAT reverse charge?
Any services that form an integral part of the activities below, or their preparatory work, will attract the VAT reverse charge. Such services include:
Earth-moving excavation or site clearance.
Building, repairing, altering, extending or demolishing any permanent or non-permanent structure, including those installed offshore.
Any works (including maintenance) relating to walls, roadworks, railways, aircraft runways, docks and harbours.
The installation in any building or structure of lighting, heating or air conditioning systems, ventilation systems, power or water supplies, sanitation, drainage or fire protection.
Any works (including maintenance) relating to water mains, sewers, inland waterways, wells, reservoirs, pipelines, land drainage installations, coast protection or defence.
Painting and/or decorating of any structural or building surfaces, whether internal or external.
Any works (including maintenance) relating to electronic communications apparatus or power lines.
Internal cleaning of buildings and structures as part of a construction, repair, extension, alteration or restoration project.
Unlike the CIS scheme, VAT reverse charge not only applies to everything listed above, but also to any construction materials used directly for the work.
When does the reverse charge not apply?
The CIS reverse charge does not apply if:
The supplies are VAT exempt.
The customer and the supplier are connected or linked.
The supplies are not covered by the CIS.
A heads up for subcontractors
If you’re a subcontractor looking to invoice a customer in a supply chain, VAT should either be charged as normal (if the new measure doesn’t apply), or covered under the reverse charge. If the reverse charge is used, then the invoice must not include VAT.
The one thing that’s so important with the VAT reverse charge mechanism is transparency. This means that it must be made clear on all subcontractor invoices if the VAT reverse charge applies so that customers are aware. The invoice should also state the amount of output VAT to be applied (usually at the standard VAT rate of 20%).
Customers must then include the correct VAT amount on their VAT return. Only customers (or contractors where involved) need to do this – subcontractors shouldn’t include the reverse charge on their own VAT returns.
And what about main contractors?
Main contractors that receive a VAT reverse charge invoice from a subcontractor must record it as a normal expense invoice, so should include input VAT on their VAT return. They must also account for the reverse charge, as notified by the subcontractor on their invoice.
The output VAT is covered by the input VAT so they balance out – i.e there will be no effect on a contractor’s VAT liability.
Does the VAT reverse charge for construction affect Making Tax Digital for VAT?
Making Tax Digital is about how VAT is recorded and reported. VAT-registered companies are now required to use only MTD-compatible software (like Pandle for instance) for accounting and record-keeping. Because MTD should already be implemented anyway, it’s simply a case of accounting for reverse charges digitally as usual.
What about invoices for mixed supplies so there’s a VAT reverse charge component?
HMRC’s aim is to make the VAT reverse charge system as straight-forward as possible. Therefore, the VAT reverse charge should be applied for the whole invoice even if it only partially applies.
Ignorance is definitely not bliss
Although HMRC has indicated a “light touch” approach to enforcement for the first six months, all construction sector businesses need to know the new rules. Penalties may be imposed for errors in VAT returns, particular once the new legislation beds in. Government guidance is available on this topic with regular updates expected.