If your business operates in the construction industry, you’ll no doubt have heard rumblings of changes to how VAT is handled.
Due to the UK leaving Europe at the end of 2020, the changes due to arrive in October 2019 were postponed until October 2020, and then further postponed due to the COVID19 until March 2021.
But what exactly are the changes, and how will it affect your business? Let’s take a deeper look.
What is the VAT reverse charge?
Its full name is ‘The VAT domestic reverse charge for building and construction services’.
It’s a change in how VAT is handled for certain kinds of construction services in the UK, along with the building and construction materials used directly in those services.
It doesn’t apply to building and construction materials supplied separately and independently of services.
It acts similarly to the current CIS scheme as it aims to stop VAT getting lost between subcontractors, contractors, and the end customer. The scheme only applies to transactions reported under the CIS and between VAT-registered contractors and sub-contractors.
This means if your business is supplying construction services to a VAT-registered customer, you’ll no longer have to account for the VAT. Instead, your customer will account for the VAT it has suffered as input tax as if they’ve made the supply to themselves.
In even simpler terms, for services they provide, sub-contractors will require the contractor employing them to handle and pay the VAT directly to HMRC.
The payment received is for the cost of the work done (plus materials used), net of any CIS deductions for tax and National Insurance, but no VAT will be paid on the invoice.
When does the VAT reverse charge start?
Why is the VAT reverse charge being introduced?
The short answer – to combat fraud. In the past, the construction industry has been known to be a little “creative” in accounting for monies – especially taxes – and this is why CIS was brought in. Businesses would often disappear without paying their VAT bill, which essentially means they take 5% to 20% additional profit that doesn’t belong to them.
By moving VAT down the supply chain, HMRC plans to make this type of VAT fraud impossible.
How does the VAT reverse charge work?
When a supplier sends an invoice to its customers, these will only include the amount charged for services, excluding VAT. However, invoices will need to include wording to show that the reverse charge scheme applies.
You’ll already see it on some services provided by big software firms such as Microsoft.
Then, it will be a responsibility of the customer or the contractor employing the subcontractor to pay this output tax directly to HMRC.
In other words, sub-contractors – such as suppliers of materials and services in the construction industry – will need to notify their customer regarding the need to pay the VAT themselves.
If your business isn’t VAT registered then the reverse charge can’t be applied to you, and standard VAT rules apply for the supplier (they charge you the VAT and account for it as usual).
Crucially, reverse charges don’t contribute to a company’s potential VAT threshold. So, if you aren’t registered for VAT then any attempt to apply the reverse charge will not push you over the limit.
Notably, the reverse charge also doesn’t apply to end-users, such as the people using a building that’s been constructed by the provided services, and nor does it apply to some of those connected to them, such as landlords or tenants.
How do I know if it the VAT reverse charge applies to my business?
For the sake of clarity, HMRC says the VAT reverse charge for construction doesn’t apply to sub-contractors unless the answer to all of the following questions is positive:
- Are any of the supplies you are making within the scope of the CIS?
- Is the supply standard or reduced-rated?
- Is your customer VAT registered?
- Will your payment be reported under CIS?
- Are you sure the customer is not an end-user?
What services does the VAT reverse charge apply to?
According to HMRC, the reverse charge applies to the following, with the inclusion of any services that form an integral part of the items below, or are preparatory to them, or are for rendering them complete (for example, site clearance or earth-moving excavation):
- Construction, alteration, repair, extension, demolition or dismantling of buildings or structures (whether permanent or not), including offshore installations.
- Construction, alteration, repair, extension or demolition of any works forming, or to form, part of the land, including (in particular) walls, roadworks, power lines, electronic communications apparatus, aircraft runways, docks and harbours, railways, inland waterways, pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence.
- Installation in any building or structure of systems of heating, lighting, air conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection.
- Internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration.
- Painting or decorating the internal or external surfaces of any building or structure.
Remember, the reverse charge applies to the services listed above plus any construction materials used directly for those services. This is different from the CIS scheme, which doesn’t cover materials.
Are there any VAT reverse charge exemptions?
This list isn’t exhaustive, but HMRC lists the following as examples of exemptions if they’re supplied on their own:
- Drilling for, or extraction of, oil or natural gas.
- Extraction (whether by underground or surface working) of minerals and tunnelling or boring, or construction of underground works, for this purpose.
- Manufacture of building or engineering components or equipment, materials, plant or machinery, or delivery of any of these things to site.
- Manufacture of components for systems of heating, lighting, air conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection, or delivery of any of these things to site.
- The professional work of architects or surveyors, or of consultants in building, engineering, interior or exterior decoration or in the laying out of landscape.
- The making, installation and repair of artistic works, being sculptures, murals and other works that are wholly artistic in nature.
- Signwriting and erecting, installing and repairing signboards and advertisements
- The installation of seating, blinds and shutters
- The installation of security systems, including burglar alarms, CCTV and public address systems
What does the VAT reverse charge mean for sub-contractors?
If you’re a sub-contractor (i.e. you supply CIS-regulated construction services) then in most cases it means very little, because when you issue your VAT invoice you will merely be passing on the VAT charge that you would’ve accounted for anyway.
You will need to expect a change to the way you match customer’s payments against invoices issued though, as any VAT registered customers will be withholding the VAT element for CIS related supplies.
It might affect your cash flow because the VAT you previously held before paying it monthly/quarterly to HMRC will no longer be available. You should plan for this ahead of time to make sure you’re not reliant on the VAT income.
Notably, because you no longer pay VAT on your sales, you might find you become what HMRC calls a repayment trader—a business whose VAT return means they claim money from HMRC, rather than making a payment.
If this is the case, it’d be a good idea to move over to monthly VAT returns to speed up how quickly you can reclaim back the VAT you’ve suffered and help with cash flow.
When it comes to completing your VAT return, sales that fall under the reverse charge rules must not be included in Box 1 (as there is no VAT on these sales), but the total must be included in Box 6 (where you include your net sales total).
What does the VAT reverse charge mean for contractors?
If you’re a contractor (i.e. purchase CIS regulated construction services directed to the end-user (the customer requiring the work) then, in theory, it means you need to ensure that when you receive reverse charge VAT invoices you correctly account for them.
You’ll need to pay any VAT due directly to HMRC as part of your normal VAT return process instead of paying the VAT on CIS related supplies to your supplier.
Cloud software providers will be updating their systems before this comes into force, but if you don’t use cloud software, you may need to update your system.
The good news is, you’ll benefit from additional cash flow by collecting this VAT. Where you may have had to wait to reclaim VAT back on payments you’ve made to subcontractors, you now net these off in your VAT return. There should be no net impact on your overall VAT bill.
However, to make sure you don’t pay too much or too little VAT, the invoices you receive should be checked to ensure they’re correct, especially for the correct VAT rates, and to ensure the services listed are eligible for the reverse charge.
When it comes to completing your VAT return, you must include the VAT on purchases the reverse charge applies to (your sub-contractors), but you don’t include the value in Box 7 (where net purchase totals normally go). You may reclaim the input tax on your domestic reverse charge purchases in Box 4 of the VAT return and include the value of the purchases in Box 7, in the normal way.
When doesn’t the VAT reverse charge apply?
It doesn’t apply for work completed for residential customers (e.g. if you fit a boiler for a residential home), only for VAT registered businesses that fall within the CIS rules.
If services are provided to non VAT registered individuals or other kinds of non-business individuals, then standard VAT rules apply.
It also doesn’t apply for work undertaken overseas.
Where can I find out more about the VAT reverse charge?
Hopefully, this blog helped guide you through the key points and explain how the VAT reverse charge might affect your business.
If you’re still unsure about anything, this technical guide will have it covered.