VAT Domestic reverse charge for construction services in 2021
HMRC’s new domestic reverse charge for construction services comes into force on 1 March 2021.
What is the background behind this scheme?
The aim of this measure is to combat missing trader fraud in the construction sector. HMRC predict that missing trade fraud has cost the exchequer £90m in 2019/20 and £140m in 2020/21. Missing trader fraud is where VAT is reclaimed by the contractor but not paid by the supplier to HMRC.
What is the VAT domestic reverse charge for construction services?
The VAT domestic reverse charge for building and construction services, to give it it’s full name, is 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 (although it doesn’t apply to building and construction materials supplied separately and independently of any construction services).
The VAT reverse charge for construction is effectively an extension of the Construction Industry Scheme (CIS) and applies only to transactions that are reported under the CIS and are between VAT-registered contractors and sub-contractors.
The scheme means that those supplying construction services to a VAT-registered customer will no longer have to account for the VAT. Instead, the customer will account for the VAT (that is, it will be considered input tax for them, 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 will be for the cost of the work done (plus materials used), net of any CIS, but no VAT will be paid on the invoice.
Under the new regime, a VAT-registered business, which supplies certain construction services to another VAT-registered business for onward sale, will be required to issue a VAT invoice stating that the service is subject to the domestic reverse charge. However, it is the recipient that must account for the VAT due on that supply through its VAT return, instead of paying the VAT amount to the supplier. The recipient may recover that VAT amount as input tax, subject to the normal rules.
This will apply to standard VAT rates supplies, reduced VAT rate supplies. It doesn’t apply to zero-rated supplies.
Which services will it apply to?
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 that the reverse charge applies to the services listed above plus any construction materials used directly for those services. It is NOT POSSIBLE to split labour and materials relating to the same services into separate invoices to avoid apply the reverse charge.
This is different to the CIS scheme, which does not cover material.
Some services will not fall within the scope of the domestic reverse charge; however, where there is a reverse charge element in a supply then the whole supply may be subject to the domestic reverse charge.
What services are exempt from the VAT reverse charge?
HMRC lists the following as some examples of exclusions if they’re supplied on their own, although the list isn’t exhaustive:
- 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
- sign writing 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
When does domestic reverse charge not apply?
The domestic reverse charge will apply to specified services unless:
- The services are supplied to an end user, such as the property owner, or directly to a main contractor that sells or lets a newly completed building
- The recipient is not VAT registered and not required to be VAT registered
- The recipient is not registered for the CIS
- The supplier and recipient are landlord and tenant or vice versa, or
- The supplies are zero-rated.
- There are special rules if 5% or less of the total invoice is a reverse charge supply – this is called the 5% disregard rule and, in these case, normal VAT rules apply. However, this is unlikely to occur in most cases.
- If you are classified as an employment business. Please note this is different to labour only contractor, where reverse charge rule will apply. See further guidance here.
Who is an end user?
For reverse charge purposes consumers and final customers are called end users. They’re businesses, or groups of businesses, that are VAT and Construction Industry Scheme registered but do not make onward supplies of the building and construction services supplied to them.
The reverse charge does not apply to supplies to end users where the end user tells their supplier or building contractor in writing that they’re an end user.
Do invoices need to change?
Invoices for services subject to the domestic reverse charge must include all the information required on a normal VAT invoice. However, they must make it clear that the domestic reverse charge applies and that the customer is required to account for the VAT. There is no specific wording but HMRC provide examples of suitable wording:
“Reverse charge: VAT Act 1994 Section 55A applies”
“Reverse charge: S55A VATA 94 applies”
“Reverse charge: Customer to pay VAT to HMRC”
It should be clear on the invoice that the reverse charge mechanism has been applied.
You should also clearly state how much VAT is due under the reverse charge, or the rate of VAT if the VAT amount cannot be shown, but the VAT should not be included in the amount charged to the customer
Where customers issue authenticated tax receipts or self-billing invoices HMRC’s recommended wording is:
- reverse charge: We’ll account for and pay output tax of £X to HMRC
- reverse charge: As the UK customer we’ll pay output tax of £X to HMRC
What is the impact on my business?
Construction businesses will need to ensure their accounting systems are capable of processing reverse charge supplies and make ongoing checks to ensure that supplies and purchases are correctly treated. It is the business receiving the invoices whose responsibility it is to ensure that the VAT treatment has been correctly applied.
Subcontractors that rely on VAT collected from their customers as working capital until they have to remit it to HMRC are likely to suffer from the loss of cash flow. These businesses and even their customers will need to consider if payment terms need to be revisited to avoid problems in the supply chain.
Subcontractors will also need to confirm that they are working for a VAT registered business and whether they are working for an end user, or for someone connected to an end user, including landlords and tenants.
What if I am using the cash accounting or flat rate scheme?
You cannot use the VAT Cash Accounting Scheme for supplies of services that are subject to the reverse charge.
If you are using the flat rate scheme reverse charge supplies are not to be accounted for under the scheme. Flat Rate Scheme users who receive reverse charge supplies will have to account for the VAT due to HMRC and recover it simultaneously on the same VAT Return.
Users of the Flat Rate Scheme will have to consider if it’s still beneficial, as your flat rate gain may be reduced and you might be better off using the normal VAT scheme, so that you can recover VAT incurred on purchases of materials, overheads and so on.
What action should construction businesses take?
Construction businesses should:
- Read this thoroughly and read further guidance on HMRC’s website or watch their webinar.
- Review supplies made to and received from other VAT registered contractors to establish where these will be subject to a reverse charge from March 2021. You need to consider when the tax point of the transaction is, in most cases this will be the date off issue of the VAT invoice, or the receipt of payment, whichever occurs first. If the tax date is on or after 01 March 2021 then domestic reverse charge applies.
- It is good practice to regularly check the VAT status of your customers, you can do this using HMRC’s checker service.
- Obtain notification from customers that they are an end user and confirmation of their VAT registration and CIS status
- Consider any adaptations required to ensure accounting systems can deal with this change. Due to the complexities of this new legislation our bookkeeping spreadsheet can no longer be used to prepare your VAT returns and we recommend that purchase bookkeeping software, such as-
- Quickbooks online
- Free Agent (free if you have a NatWest bank account)
- Sage 50 Cloud Accounts and Sage Business Cloud Accounting
- If you fall within these new rules and you continue to use our spreadsheet your VAT WILL be wrong, which may result in additional costs by us when preparing your year end accounts and penalties by HMRC.
- If you currently use bookkeeping software you will need to ensure that you keep up to date with the changes they are implementing to account for the domestic reverse charge.
- Consider the impact on cash flow from March 2021 and if there are any other ways to mitigate this.
- Finally, HMRC will issue penalties for non-compliance of these new rules and therefore it is worth spending time familiarising yourself with the rules and how they affect your business
I’m a subcontractor. What does the VAT reverse charge for construction services mean for my business?
Now you have read the details around the scheme, check out our simplified guide for sub-contractors.
I’m a contractor. What does the VAT reverse charge for construction services mean for my business?
Now you have read the details around the scheme, check out our simplified guide for sub-contractors.
The VAT domestic reverse charge was initially due to come into force in October 2019. This was pushed back until October 2020 to enable businesses to prepare for it. Due to the pandemic the decision was made in June 2020 to delay this by a further 5 months to 01 March 2021.
Whilst there is no discussion currently about postponing this change again, you should keep up to date with any announcements from us or HMRC, in relation to this.
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