Construction industry VAT changes will have a major impact on the accounting practices and cash flow of construction businesses. HMRC’s new domestic reverse charge for construction services was due to start from 1st October 2019, but HMRC announced in September 2019 that this new scheme has been delayed until October 2020. This new scheme will affect you if:
- You have a VAT registered construction business which undertakes work for, and invoices, another VAT registered construction business, ie your business is a sub-contractor; or
- You have a VAT registered construction business which commissions work from another VAT registered construction business, and your business pays the invoice, ie. The invoice is not passed on to the end-client.
The aim of this new measure is to combat VAT fraud in the construction sector; and will result in changes to how construction businesses invoice and complete their VAT returns.
Changes to the VAT Return
Under the current rules, a sub-contractor charges VAT to their customer, collects the VAT from the customer and accounts for it in Box 1 of their relevant VAT return.
This is changing for supplies between VAT-registered businesses in the building-trade. The sub-contractor will invoice their contractor-customer without charging VAT and the customer makes the Box 1 entry instead on their own VAT return.
In effect, there will be no cash flow issue for the contractor receiving services because the same amount of VAT declared in Box 1 will also be included as input tax in Box 4: ie a nil effect overall. This is known in VAT speak as a “reverse charge” procedure.
John is a plumber, VAT registered as a sole trader. He is doing some work on an office block, invoicing the main contractor, Phil for his work.
Phil is also VAT registered, and will invoice the building owner. Phil is not an “end-user” because he is making an onward supply of construction services to his customer. He is an “intermediary supplier”.
The invoice raised by John will be subject to the new procedures ie no VAT is charged. Let’s say the value of his work including materials will be for £5,000:
John’s VAT return will only include the value of the sale in Box 6 (outputs) of his VAT return:
• Box 6 – outputs – £5,000
Phil will do the reverse charge calculation and make the following entries on his return:
• Box 1 – output tax £1,000 (ie £5,000 x 20%)
• Box 4 – input tax – £1,000 (same figure as Box 1)
• Box 7 – inputs – £5,000 (net value of payment made to John)
To what does it apply
It will apply to services provided by one contractor for another and will cover items similar to those that are covered by the Construction Industry Scheme (CIS). This includes: construction, alteration, repair, extension, painting and decorating, plus the demolition of buildings, civil engineering and the installation of heating, lighting and air-conditioning.
Where there is a reverse charge element in a supply then the whole supply will be subject to the domestic reverse charge. Where goods and building materials are provided together with construction services and in the course of the construction work then the reverse charge also applies to these goods. There are likely to be cases where it is difficult to determine if there is a separate supply of goods that is excluded from the reverse charge, or whether they are to be included as part of a single supply of construction services. In these cases, a business will need to consider the position further to ensure the correct VAT treatment.
When does it not apply
The domestic reverse charge will apply 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 makes onward supplies of those construction services to a connected company
- The recipient is not VAT registered, or required to be VAT registered
- The recipient is not registered for the CIS
- The supplier and recipient are landlord and tenant or vice versa
- The supplies are zero-rated.
The supplier and recipient of the services both have new responsibilities as part of this new system:
Taking the Phil and John example above:
- John must ensure that Phil is both registered for the CIS (Construction Industry Scheme) and also has a valid VAT number.
- John must also specify on his sales invoices the amount and rate of VAT that Phil must declare with the reverse charge ie 5% or 20% VAT.
- John should include wording on the sales invoice along the lines of: “Reverse charge: customer to pay the VAT to HMRC.”
- Phil must tell John if he is an “end-user” or “intermediary supplier”. If he is an intermediary supplier, then John will not charge him VAT because the reverse charge applies.
- It is important that Phil does not pay VAT incorrectly to John because HMRC could raise an assessment for the VAT that he should have declared, ie as if the reverse charge had been done correctly.
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.
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. As the VAT amount must still be shown on invoices subject to the domestic reverse charge, there is a risk that suppliers will account for the VAT to HMRC in error and customers will recover it from HMRC.
Businesses that rely on VAT collected as working capital until they have to remit it to HMRC will suffer from the loss of cash flow. These businesses should consider if payment terms need to be revisited to avoid problems in the supply chain.
Businesses will also need to confirm if 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.
Federation of Master Builders
The Federation of Master Builders undertook a survey of around 8,000 SME construction firms and found that 69% were not aware of reverse charge VAT at all. Of those who were, 67% had not prepared for the changes. The FMB therefore warned of potential ‘chaos’ when the new regime began in October 2019, and requested a delay in the implementation of this new system.
Regardless of the delay, we would urge our clients affected by reverse charging to consider how they will handle these changes. If you have any queries please contact Jackie or Andrew on 01625 524127 or contact us here.