Background
HMRC sees 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 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, including building work, 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 VAT-registered building contractors engaging VAT-registered sub-contractors and, similarly, to sub-contractors engaging others through the supply chain. A final customer for building work, such as an occupier or a developer, will not have to apply the reverse charge, and will continue to incur VAT in the same way as now.
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 but with some notable differences.
- Not all supplies within the CIS will be subject to the reverse charge. There will be various exclusions which will be particularly relevant to ‘deemed contractors’.
- 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.
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;
- The customer is not (and is not required to be) VAT-registered; or
- The customer is treated as or like an ‘end user’ or is not acting in a business capacity.
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 does apply, its actual application may be relatively straightforward, at least once accounting systems have been adapted to deal with it.
The customer needs to declare as output tax whatever VAT the supplier would have charged, without the reverse charge, and to do so in the period when the tax point arises.
If a supplier charges VAT, the customer needs to be satisfied that it is actually due: if not, it will not be recoverable as input tax. Otherwise, the customer can treat the same amount of VAT as input tax, in the same period. It will normally be directly attributable to an onward supply of building work, and recoverable in full. If so, the reverse charge has no net effect.
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 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. It may also be helpful to consider HMRC’s guidance.