The VAT reverse charge has been being talked about for some time, in relation to those businesses operating in the construction industry. In fact, the industry has now been ‘awaiting’ its arrival since 2019.
Originally scheduled for 1 October 2019, it was then pushed back to 1 October 2020 due to Brexit fears and then once more, to 1 March 2021, as a result of the Coronavirus pandemic.
So now the reverse charge is a little less than eight weeks away; in respect of timing, we appreciate that businesses still have a huge amount to contend with at present but, if your business is going to be impacted by this, you need to prepare.
What is the VAT reverse charge?
From 1 March 2021, the domestic VAT reverse charge must be used for most supplies of building and construction services. The charge applies to standard (20%) and reduced rate (5%) VAT services:
- for individuals and businesses registered for VAT in the UK; and,
- reported within the Construction Industry Scheme (CIS).
A classic scenario would be a subcontractor working for the main contractor on a particular project.
It is conceivable that you may need to apply the VAT reverse charge on the sale and/or purchase of goods. To help you determine if the goods or services you have supplied or purchased fall within the remit of the charge, more detail is available on GOV.UK, here.
You should apply the charge to services involving the constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services.
You should not apply the charge to the professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants, when supplied on its own. The charge will also not apply where an agency provides staff supplying services – i.e., an electrician sent out by an agency, to a construction business.
Where a supply is made to a main contractor who is VAT and CIS registered, and it is subject to the domestic VAT reverse charge, the parties would account for VAT as follows:
- The subcontractor would issue an invoice to the main contractor, for the appropriate amount less VAT – for example, let us say the services provided cost £15,000 less VAT, the invoice would be for £15,000 as no VAT is charged. The invoice should also clearly illustrate that the reverse charge has been applied.
- The subcontractor will declare the sale in Box 6 of his VAT return i.e., outputs.
- The main contractor will account for output tax of £3,000 (20% VAT) in Box 1 of their return. The same amount will be claimed as input tax in Box 4. The net value of £15,000 is included in Box 7.
Importance of ‘end user’ and ‘intermediary supplier’ status
If there is no ‘onward supply’ of the goods or services provided by the subcontractor, then the main contractor would be considered an end user. In this instance, the appropriate rate of VAT would be charged by the subcontractor as normal. Intermediary suppliers are businesses registered for both CIS and VAT that are connected to end users – i.e., a landlord and tenant arrangement. Where an intermediary supplier makes a supply of services to the end user, normal VAT rules will also apply. To ensure rules are applied correctly, suppliers must have written confirmation where a customer is either an end user or intermediary.
The 5% disregard rule
There is another important scenario that does not require the VAT reverse charge to be applied; namely, where 5% of less of the total value of the invoice would otherwise be subject to the charge. This is a nuance that has only been added to the rules recently.
For example, a subcontractor is carrying out two jobs for a construction industry client –, one job is within scope of the reverse charge, whilst the other is not considered reverse charge work. A single invoice is issued but, because the reverse charge element of the work represents only a small portion of the total value, normal VAT rules apply.
Subcontractor and main contractor responsibilities, and the impact of the reverse charge on cash flow…
The recipient of services (i.e., main contractor) in any scenario should notify the supplier of end user or intermediary supplier status, to ensure that VAT is charged correctly. Suppliers are expected to take a careful approach by charging VAT as normal unless told otherwise.
Paying VAT on a reverse charge supply could leave buyers open to a double VAT hit should HMRC assess output tax, but incorrect application of the reverse charge by the supplier could leave them liable for output tax that should have been invoiced for.
Incorrect application aside, the cash flow of many construction industry businesses will be impacted by the correct use of the rules. Simply, suppliers will not be paid the VAT amounts that they would previously have received, and those in receipt of reverse charge goods or services will need to ensure sufficient funds are reserved to pay output tax due upon their next return. In both instances, working capital is compromised.
In some cases VAT Returns could become repayments and so opting to file monthly VAT returns may be something you wish to consider.
To round off this whistle-stop tour of the VAT reverse charge, there are questions that construction businesses should be asking themselves ahead of 1 March 2021, to ensure they are best prepared to comply, including:
- Which of your supplies and/or, purchases may fall within scope of the reverse charge?
- What changes do you need to make to your invoices to reflect the charge – i.e., alternative wording?
- Can your current accounting systems and software deal with the reverse charge?
- Are there any staff responsible for VAT accounting within your business, and are they familiar with the new rules?
How can George Hay help you with the domestic VAT reverse charge?
Our team of chartered accountants and business advisers can help your construction business to make any necessary changes, in respect of accounting procedures and use of software, to accommodate the new rules.
We will work with you to ensure that you understand how the rules may impact your cash flow and that you have the confidence to process affected transactions correctly, after 1 March 2021.
As the implementation date approaches, it is worth contacting any VAT-registered subcontractors or main contractors that you work alongside to ensure both you and they are clear about what is required under the new rules. If you anticipate that the VAT reverse charge will affect your business, or if you are concerned about successfully complying with the legislation, contact us today.