Fundamental Changes to VAT in the Construction Sector
Reducing VAT Fraud
In order to reduce VAT fraud in the construction industry HMRC are introducing the reverse charge which will be effective from 1 October 2019. The domestic reverse charge is a major change to the way VAT will be collected in the building and construction industry. Subcontractors will not charge VAT on their invoices to contractors (provided both parties are registered for VAT).
HMRC published guidance VAT: domestic reverse charge for building and construction services on 7 June 2019 and this contains further detailed comment.
Services affected by the domestic reverse charge
The reverse charge will affect supplies of building and construction services supplied at the standard or reduced rates that also need to be reported under the Construction Industry Scheme (CIS), but with the following notable differences. These are called ‘specified supplies’.
- The reverse charge will not apply to zero-rated supplies.
- The reverse charge will extend to building materials included within a supply of building work.
- Deductions under the CIS do not affect the amount of VAT due.
If any of the services in a supply are subject to the reverse charge, all other services (even services that would be excluded if supplied alone) will also be subject to the reverse charge. For example, a joiner constructing a staircase offsite then installing it onsite is making a reverse charge service, even if the charge for installation is only a minor element of the overall charge.
You can find a list of services which are subject to the domestic reverse charge and a list of services which are excluded from the domestic reverse charge by clicking this link VAT: domestic reverse charge for building and construction services.
How the domestic reverse charge will work in practice…
The reverse charge will apply to VAT-registered building contractors engaging VAT-registered subcontractors and, similarly, to subcontractors engaging other subcontractors through the supply chain. A final customer for building work, such as an occupier or a developer, will not have to apply the reverse charge, and will continue to be charged VAT in the same way as now.
The effect of these changes will mean that the contractor customer will not pay VAT to subcontractors on such supplies, but will instead account for this itself on its own VAT return by an ‘on return’ adjustment.
When supplying a service subject to the domestic reverse charge to a contractor customer, subcontractors must:
- Show all information usually required on a VAT invoice.
- Include a narrative on the invoice to make it clear that the domestic reverse charge applies and that the customer (i.e. the main contractor) is required to account for the VAT.
- Clearly state how much VAT is due under the reverse charge, or rate of VAT if VAT amount cannot be shown. The VAT shown should not be charged to the main contractor.
- Subcontractors will not be responsible for accounting for the VAT stated on the invoice.
If you use software to produce invoices, and your system cannot show the amount of VAT to be accounted for under the reverse charge, the wording should state that VAT is to be accounted for by the contractor customer at the standard or reduced rate of VAT, based on the VAT exclusive selling price for the reverse charge goods or services. The reverse charge goods or services must be identifiable on the invoice. HMRC suggests a narrative such as “customer to account to HMRC for the reverse charge output tax on the VAT exclusive price of items marked reverse charge”.
Where construction projects are subject to mixed VAT rates, the reverse charge will need to reflect this. Subcontractor’s will remain responsible for ensuring the correct amount of VAT is stated (for reverse charge purposes only) on invoices issued even though they will not charge this or pay this to HMRC.
The reverse charge will apply wherever the tax point for a supply is on or after 1 October 2019. A tax point is normally set by the date of the invoice to contractor customer or payment is received (if earlier)
Impact of the reverse charge on contractors
Contractors will need to review processes to ensure their accounting systems and software can deal with this change. It is important that you make sure that all staff who are responsible for VAT accounting are familiar with the reverse charge and how it works.
If Rayner Essex assist you with your bookkeeping our staff will deal with this on your behalf.
Completing your VAT Return
VAT on sales
For sales under the domestic reverse charge suppliers must not enter any output tax on sales to which the domestic reverse charge applies in box 1 of the VAT Return. The net value of the sale must be entered in box 6.
VAT on purchases
If you are purchasing a service subject to the reverse charge, you must enter the output tax on purchases the domestic reverse charge applies to in box 1 of the VAT Return. Make sure you do not enter the net value of the purchase in box 6.
You may reclaim the input tax on your domestic reverse charge purchases in box 4 subject to the normal rules, and you should enter the net value of the purchases in box 7 as normal.
Consideration will need to be given as to whether the introduction of the reverse charge will impact cash flow. With the introduction of the reverse charge, subcontractors will no longer receive payments of VAT on supplies in order to account for VAT to HMRC. This may significantly impact on cash flow.
Additionally, if a business is now in a repayment position it may be useful to consider completing monthly VAT returns. We would recommend that you contact us to ensure that processes are in place to account for VAT correctly from 1 October 2019 and to ensure negative cash-flow issues are mitigated where possible.
Should you have any queries please do not hesitate to contact your usual Rayner Essex team member.
If you have any questions relating to VAT and how some of the issues discussed in this article may affect you, our VAT team will be happy to help. Please fill out the contact form below and we will respond.