Reverse charge construction
By Philip McNeill, Head of Taxation (Tax Practice and Owner Managed Business Taxes)
1 July 2019
The information included in this article was correct at the time of writing. Please follow this link for an updated version.
New guidance published by HMRC at the start of June 2019 adds detail and confirms the scope, including the need for suppliers of construction to know their customers’ VAT and CIS status. Philip MacNeill reports.
Tax avoidance
A new plank in the Government’s anti-avoidance repertoire is to be put in place in October. It applies to VAT registered businesses supplying construction services. To attack missing trader fraud in the construction sector, responsibility for accounting for output tax moves from subcontractor to the contractor for supplies covered by the Construction Industry Scheme (CIS).
A similar arrangement already applies to mobile phones and some other ‘at risk’ supplies. The construction reverse charge will be similar but with some significant differences.
Scope of the changes
The reverse charge will apply to:
- VAT registered businesses in a CIS supply chain.
- supplies of ‘specified services’ – meaning construction services (but not, for example, property or land).
- supplies of labour and materials charged at standard or reduced rate VAT.
It does not apply to supplies outside CIS, to non-VAT registered businesses or to zero-rated supplies. In these cases, normal VAT invoicing rules apply.
Reverse charge does not apply to ‘end users’ customers. These are VAT registered businesses who do not supply on construction services received. This could include, for example, a large retailer having a store built, or a construction business making a supply of property – such as a newly built office block or warehouse.
Where reverse charge does not apply, supplies are invoiced under the normal rules.
Impact of VAT reverse charge
Businesses will need advice on record keeping requirements and impact on working capital.
Key impacts of the changes include:
- cashflow – subcontractors lose output tax which could be used as working capital. This will particularly impact subcontractors suffering 20% CIS income tax deductions on work done.
- subcontractors may become repayment cases, as input tax may now exceed output tax. They may be more under the HMRC spotlight as a result; they may also wish to consider moving to monthly accounting. Timing of any transfer from quarterly returns to monthly returns will need careful attention.
- subcontractors using the VAT flat-rate scheme may find that the scheme is no longer appropriate for them. Reverse charge supplies are outside the flat rate scheme, while the flat-rate scheme bars reclaiming input tax.
- subcontractors on the VAT cash accounting scheme face potentially complex book-keeping challenges as Reverse charge supplies cannot be accounted for under the cash accounting scheme. Supplies on non-reverse charge supplies may still be reported under the cash accounting scheme.
- invoicing – both subcontractors and contractors may need to change their invoicing procedures:
- reverse charge invoices are issued by the subcontractor when reverse charge applies. They must include specific details – such as saying that the reverse charge applies/customer accounts for the VAT. The invoice should show the amount which would have been charged as VAT, but it must not be shown as VAT payable.
- subcontractors will need to know more about their contractors to get invoicing right. They will need to know if the contractor is VAT registered, and if the supply is within CIS reporting, before making out the invoice.
- contractors will need enough information and expertise to make out a VAT invoice correctly for the supplies they receive under reverse charge.
- the final contractor in the CIS supply chain will need to know if their customers are ‘end users’ – that is, VAT registered businesses which will not be making onward supplies of construction services, or if they are not registered for VAT. Invoicing for end users customers and non VAT-registered customers will follow normal VAT rules and Reverse charge will not apply.
- Normal (non reverse charge) invoicing will also apply to ‘intermediaries’. Intermediary suppliers are VAT and CIS registered businesses that are connected or linked to end users. To be connected or linked to an end user, intermediary suppliers must either share a relevant interest in the same land where the construction works are taking place, or be part of the same corporate group or undertaking.
To help manage the transition, HMRC is permitting an easement for existing supplier arrangements ‘if …. across all construction contracts with a sub-contractor …… reverse charge applies to more than 5% of contracts (by volume or value) with that sub-contractor, then the reverse charge may be applied to all the contracts.’
VAT return entries
Where reverse charge applies, the supplier’s VAT returns shows the output, but not the output tax on the supply. While the customer’s VAT return shows output tax on the supply, but not output, and it also shows the input and input tax on the supply, subject to normal input tax recovery rules.
Penalties
HMRC has noted that it understands the difficulties businesses may have in implementing the domestic reverse charge and will apply a light touch in dealing with related errors that occur in the first 6 months after introduction, where businesses are trying to comply with the new legislation.
However, businesses that knowingly claim end user status when the domestic reverse charge should have applied will still be liable for the output tax that should have been paid and may be liable for penalties.
Further information
VAT reverse charge for building and construction services guidance notes:
Previous guidance issued November 2018
There is a useful flowchart in the annex to the November 2018 HMRC guidance note
Final draft of the Statutory Instrument
Domestic reverse charge procedure (VAT Notice 735) – as it currently applies to other services