HMRC views the construction industry as a sector that presents a significant risk to the Exchequer. As a result, a reverse charge for building work is to be introduced to combat fraud. This was originally due to be introduced on 1 October 2019, but its implementation has been delayed several times. Once implemented the new legislation will mean, essentially, that building contractors will not pay VAT to their VAT registered sub-contractors but will account for it themselves. It is important that all affected parties familiarise themselves with the new rules before they are introduced on 1 March 2021.
Reverse charge accounting already exists in other areas seen as susceptible to fraud, notably mobile phones and computer chips. The reverse charge also applies (for reasons not associated with combating avoidance) to some goods and services received from outside the UK. The proposed construction reverse charge mechanism is therefore sometimes referred to specifically as the ‘domestic reverse charge’, or DRC.
How will the new reverse charge work in practice?
The reverse charge will apply to building contractors engaging sub-contractors and, similarly, to sub-contractors engaging others through the supply chain where the parties involved are registered for VAT and the payment for the supply is reported within the Construction Industry Scheme (CIS). It shifts the responsibility to account for VAT on the supply from the VAT registered supplier to their VAT registered customer. A final customer (‘End user’) for building work, such as an occupier or a developer, does not have to apply the reverse charge, and can continue to incur VAT in the same way as now. This also applies to “intermediary suppliers” who purchase and re-supply construction services without any substantial input. Both end users and intermediate suppliers are discussed in greater detail below. It should be noted that normal accounting will only apply if customer notifies the supplier that it is an end user or intermediary supplier and that this notification will apply on a contract by contract basis.
The reverse charge is aligned with the Construction Industry Scheme (CIS), and will only apply to supplies that are within the scope of the CIS. However, not all supplies within the CIS will be subject to the reverse charge. There are several exceptions relating to the status of the customer which are covered in greater detail below but, in addition:
- The reverse charge will not apply to zero-rated supplies.
- The reverse charge will extend to building materials included within a supply of building work.
- Deductions under the CIS do not affect the amount of VAT due.
The DRC will not apply where a customer advises that, for the purposes of a particular supply being made to it, it is an:
- “End User”; or,
- An “Intermediary Supplier”
HMRC defines end users as ‘…businesses, or groups of businesses, that are VAT and Construction Industry Scheme registered, but do not make onward supplies of the building and construction services supplied to them.’ Intermediary suppliers are VAT and Construction Industry Scheme registered businesses that are ‘connected’ or ‘linked’ to end users.
Parties are “connected” or “linked” in the context of the DRC, where they are in a group of companies or where the intermediary has an interest in the land where works are taking place e.g. landlord and tenant.
When contracting, the onus is on the customer to notify, in writing, its status to the supplier. In these circumstance a VAT invoice should be raised. Without notification from the customer that it is an end user or intermediary supplier VAT should not be charged by the supplier from 1 March 2021. HMRC Guidance on end users, intermediaries and notification can be read here.
Where the DRC is payable, the invoice issued by a supplier to their customer, from 1 March 2021, should be net of any VAT due. The invoice must show that the reverse charge applies and the relevant VAT rate and should make clear that it is the customer’s responsibility to account for output VAT and HMRC’s suggested wording is as follows:
Customer to account to HMRC for the reverse charge output tax on the VAT exclusive price of items marked ‘reverse charge’ at the relevant VAT rate as shown above.
For the purposes of the reverse charge, contractors and sub-contractors include anyone who is acting in that capacity by making a supply of building work, whether or not this is their normal activity. HMRC have confirmed that staff agencies acting as such are not seen as supplying building work, so that their services are outside the scope of the reverse charge.
If a supplier charges VAT, the customer needs to be satisfied that it is actually due. If VAT is charged incorrectly it will not be recoverable as input tax. This is particularly important because when HMRC disallows a VAT refund claim, the customer will need to seek a recovery of overcharged VAT from the supplier which may be straightforward but can be difficult or impossible, for example, if the supplier is no longer trading. In this context it is important to note that, despite CJEU judgments to the effect that customers who cannot obtain rebates from suppliers should have available a mechanism to obtain a refund from HMRC, HMRC has, at time of writing, refused to accommodate this and whilst accepting claims may be possible it has adopted a policy of requiring businesses to make claims via the High Court, an expensive and uncertain approach. In essence HMRC is only too pleased to accept windfalls, collecting VAT from suppliers that have charged it incorrectly whilst refusing to offer any practical solution to reclaiming that VAT other than via the supplier.
There are various situations, set out in the relevant legislation, where the reverse charge will not apply, otherwise, the presumption is that the reverse charge does apply. In particular, there will be no de minimis threshold.
The supplier should not charge VAT unless:
- The payment is outside the scope of the CIS; or
- The customer is not (and is not required to be) VAT-registered; or
- The customer has notified that it is an End User or Intermediary Supplier.
Additionally the supplier should not charge VAT if the supply is zero-rated, or if it is not VAT registered or required to be registered.
Accounting for the reverse charge
If the reverse charge is applicable to a particular supply, the accounting procedure is relatively straightforward. No VAT will be due on payments from customers where the supply is covered by the reverse charge. The net value of the sale should be included in the VAT return which covers the period in which the supply is made. If you are receiving a supply subject to the reverse charge the VAT due should be shown in Box 1 of the VAT return, the net value of the supply in Box 7 and input VAT should be recovered, in accordance with the normal rules, in box 4.
As highlighted, the onus is on the customer to confirm its status as either an end user or intermediary if the reverse charge is not to apply. If you are a supplier and do not receive such a notification then your supply should be treated as subject to the reverse charge.
Where a supplier receives a notification from its VAT registered customer that it is either an end user or a qualifying intermediary, then VAT should be charged and declared as usual.
Impact of the reverse charge
The reverse charge may have some significant commercial implications, particularly for small sub-contractors. There will be an impact on cash flow where businesses have previously used VAT collected to finance their business. Additionally if a business is in a repayment position as a consequence of no longer having to pay VAT to HMRC they will have to wait for the refund to be processed by HMRC rather than offsetting input VAT against output VAT on a VAT return. Businesses that expect to be regularly in a repayment position may wish to switch to monthly VAT returns.
Contracts for building work will need to accommodate the new regime and in cases of uncertainty professional advice should be sought. This blog is intended to give an overview and where there is uncertainty Constable VAT would be happy to assist further.
Please note that this blog post is intended to provide a general overview of the subject. No liability is accepted for the opinions it contains or for any errors or omissions. Constable VAT cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this blog post. Specialist VAT advice should always be sought in relation to your particular circumstance.