The VAT reverse charge is being extended to include construction businesses on 1 March 2021 so every business involved in a construction industry supply chain needs to take action now to ensure they are ready. It is estimated that more than a third of those affected are not aware of the new rules.
If you are not sure if the VAT reverse charge changes applies to you, our tax experts have produced a quick guide to explain the changes…
What is changing?
The new VAT reverse charge rules state that when a VAT-registered business supplies construction services to another VAT-registered construction business, they will be required to issue a VAT invoice saying that the service is subject to the domestic reverse charge, but no VAT will be added to the invoice.
Importantly, instead of paying VAT to the supplier, the recipient must now show the VAT due on its VAT return. The recipient can then recover the VAT as input tax.
When will the VAT reverse charge apply?
In simple terms, the changes affect construction firms supplying specific services to other VAT-registered businesses, who then supply these to someone else. These specified services are defined by HMRC under the Construction Industry Scheme (CIS).
To find out what work is covered by CIS, please see the HMRC guide: https://www.gov.uk/what-is-the-construction-industry-scheme
The VAT reverse charge affects the lifecycle of a building from its construction, through alterations and repairs, and then finally its demolition. It is estimated that the VAT reverse charge will affect around 150,000 businesses, including both property developers and construction companies.
You need to apply the reverse charge when all the following are met:
- the supply for VAT consists of construction services and materials
- it is made at the standard or reduced rate of VAT
- the invoice is between a UK VAT registered supplier and UK VAT registered customer
- supplier and customer are CIS registered
- the customer intends to make an ongoing supply of services to another party
- the supplier and customer are not connected.
Who decides when the rules apply?
Construction supply chains can be complicated, so the rules are intended to smooth things out by adding a reverse charge to the whole supply chain, rather than each individual transaction or link.
Crucially, the decisions can be made on site between the parties involved. For example, if a company supplies specified services on a site and is then asked to supply further work, then all the services on the site could be covered by the VAT reverse charge.
By putting the responsibility in the hands of the businesses on the ground, it is hoped that the whole process is speeded up and is applied in the most practical way.
It is important to identify the services which do and do not come under the VAT reverse charge, so that the VAT paperwork for the project is accurate.
Are there exemptions?
As with any new tax legislation, there are always exemptions and caveats. One helpful thing to note is that if there are a few jobs on site that are not covered by the VAT reverse charge, you can still include them if the whole supply has an element of VAT reverse charge.
The VAT reverse charge will apply to specified services unless:
- services are supplied to an end client (property owner or developer who sells/lets the building)
- the recipient makes onward supplies of construction services to a connected company, which is an end client
- the recipient is not VAT registered
- the recipient is not registered for the CIS
- supplier and recipient have a landlord and tenant relationship
- supplies are zero-rated.
In relation to the first point, the issue of onward supply is vital when determining whether the VAT reverse charge applies. Customers must inform their supplier in writing that they are an end user, otherwise the supply will come within the scope of the VAT reverse charge.
It should be standard practice for these issues to be covered in any construction contract, which should also state each party’s VAT and CIS status, plus their VAT numbers.
What information should be included on invoices?
Any invoice covering services that qualify for the VAT reverse charge must include all the details on their normal VAT invoice. You must state how much VAT is due under the reverse charge, or the VAT rate if an exact amount is not shown.
Clearly state whether the VAT reverse charge applies to the work, and that your customer will account for the VAT. For example, you could simply say: “Reverse charge: VAT Act 1994 Section 55A applies”.
What do the changes mean for construction companies?
Every construction company needs to ensure that their invoicing and accounting systems are up to speed with the new legislation and are able to process supplies covered by the VAT reverse charge. Because the VAT amount still needs to be shown on invoices, we expect that many suppliers will mistakenly account for the VAT to HMRC.
Sub-contractors must understand whether they are working for a VAT-registered company and whether they are working for a business within CIS that is not an end client (developer, landlord, tenant etc).
Some sub-contractors may suffer in cashflow terms if they have been using the VAT from customers as working capital. Our advice is to calculate what the new rules mean to you and then to adjust your procedures and payment terms to mitigate the loss in revenue.
What actions should my business take?
There are some important steps that every construction business should take before they send out their March invoices:
- determine which jobs for VAT-registered companies will fall under the VAT reverse charge from 1 March 2021
- where necessary, gain written confirmation from customers their VAT and CIS status an whether or not they are end clients
- review and update accounting procedures
- calculate the loss of cash flow and review payment terms
- if possible, move to monthly VAT returns
- if you fall under the VAT reverse charge, come off the Cash Accounting Scheme
- if you’re on the flat-rate scheme, check that it is still right for your business
- consider asking suppliers to purchase materials on jobs covered by the VAT reverse charge to lower your exposure to VAT payments.
How will it work in practice?
Bob the brickie is VAT registered and supplies services to a construction firm (VAT registered) who is building a new warehouse for a developer (VAT registered) who is the customer/end user.
Under the old VAT rules, Bob would invoice the construction firm for £60,000 (£50,000 bill for materials and labour plus £10,000 VAT).
From March 1, 2021, Bob’s invoice now says £50,000 and states that the VAT reverse charge applies. The construction firm pays him the net £50,000 fee and then accounts for output and input VAT of £10,000 on their VAT return.
Because Bob does not account for output VAT in his accounts, he receives £10,000 less under the new system. However, he does not have to account to HMRC for any output tax on the transaction.
So although Bob’s cashflow has reduced, the construction firm has gained as they do not have to pay Bob £10,000. However, at the end of its VAT quarter it cannot reclaim the £10,000 as it is accounting for the reverse charge and the output VAT offsets the input VAT.
Do you need help?
If you have any questions or require advice on how the VAT reverse charge will affect your construction business, please get in touch.
