Colin Laidlaw and Rupert Moyle explain the new VAT domestic reverse charge for construction services
A significant change to how contractors in the supply chain account for VAT comes into effect on 1 October. The new rules remove the current requirement for VAT to be charged on sales invoices from one contractor to another.
Why is this change happening?
The most common fraud in the building industry from HMRC’s perspective is missing trader fraud committed by subcontractors that provide labour for construction services. HMRC estimates that more than £100m a year is lost by this and similar types of fraud and current efforts to protect revenue, such as seeking security deposits in advance, have not been successful.
Fraudulent activity typically works in the following way. Labour suppliers will provide staff, charging labour plus VAT to the main contractor, and get paid in the usual way – but then “disappear” before paying the VAT they collected from the client over to HMRC. Often the organisation responsible starts again under a different name and structure, which makes it difficult for HMRC to enforce any previous VAT debt.
The simplest way to remove fraud is to remove the ability to charge and collect VAT from the participants; that way there is nothing to defraud.
In the 2017 Budget HMRC announced a consultation to seek opinion on the introduction of the VAT domestic reverse charge (DRC) for construction services. Following this exercise, legislation was passed, with the rules coming into effect on 1 October 2019.
The concept is not new; we already have the domestic reverse charge in the UK for certain items including microchips, mobile phones and wholesale of airtime. It is also not uncommon in the EU, with at least 18 member states currently operating a domestic reverse charge in the construction industry.
The changes explained
The DRC does not apply to the zero rate; only to supplies at the standard and reduced rates. If there are qualifying and non-qualifying supplies the DRC can apply to the whole supply. The DRC should not affect VAT recovery. Suppliers will need to check if the customer is VAT registered.
It will only apply to charges in the chain of supply and not to end users. End users are those that do not supply building and construction services. Services connected with end users are also excluded, for example recharges between landlords and tenants.
Who is an end user may not always be obvious to the contractor and the onus is on the end user to declare that it is. If not, the DRC will apply, which may result in an unexpected cost to the end user.
At present there will not be an official certificate for end users – a declaration should be sufficient. We expect HMRC to suggest suitable wording.
The DRC applies to “construction operations” that are subject to the Construction Industry Scheme (CIS). These include:
- Groundworks/other preparatory works
- Construction alterations and repair of buildings
- Installing heat, light or power systems.
- Internal and external painting and decorating.
It does not apply to professional services such as architecture or surveying; extraction of minerals and drilling for oil or gas; or repair of building components such as boilers.
And finally, VAT invoices will need to show more details:
- They need to state that the reverse charge is due
- The value of the DRC, the VAT rate applicable and the VAT due will need to be shown (but not charged and paid over to HMRC).
How does it work?
The onus to report the VAT rests with the contractors that receive services rather than with the subcontractors earlier in the supply chain. In a simple supply chain the position at present might be as follows: subcontractor to main contractor – VAT charged; contractor to end user – VAT charged. From 1 October this would change to: subcontractor to main contractor – no VAT charged (contractor applies reverse charge); contractor to end user – VAT charged (end user notification required).
Applying the reverse charge is a two-stage process for the main contractor:
- It treats the supply from the subcontractor as if it was supplied by itself and charges itself VAT (at the appropriate rate – 5% or 20%). This has to be paid to HMRC in the VAT return.
- As VAT is charged on to the end user, this DRC VAT is treated as expenditure and recoverable in the normal way (on the same VAT return).
The DRC prevents the subcontractor from charging VAT and not paying it to HMRC but should not create a VAT
cost to the main contractor; it should be tax neutral.
What do you need to do?
There is not a lot of guidance available yet on how the DRC works, but more detail should arrive in due course.
This is a change to the way contractors account for VAT, so systems may need to be changed to deal with it. The change does not take effect until 1 October and so, particularly in light of the Making Tax Digital requirements, there is time to ensure that your systems are set up to report it and recognise when it is applicable (or not).
If in doubt, talk to your advisers.
Colin Laidlaw is VAT director and Rupert Moyle is a partner and head of VAT at accountants and business advisers Kreston Reeves