25 FAQs - everything to know about the VAT Reverse Charge

The VAT domestic reverse charge more commonly known as VAT reverse charge takes effect for the construction industry on 1 March 2021. It’s an important change for many businesses within the construction sector.

Here, we list some of the most frequently asked questions on the changes and how it will affect your company…

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1. Why’s the VAT reverse charge being introduced to the construction sector?

HMRC believe the construction industry’s easily susceptible to fraud. Namely ‘missing trader fraud’. This is where a subcontractor charges VAT to its customers but disappears after a few months of trading. As a result, HMRC lose out on the VAT owed from the subcontractor. The idea is that the VAT reverse charge for Construction will restrict this VAT fraud as the reporting and payment of VAT passes to the customer.

2. Who will be affected by the reverse charge?

The VAT reverse charge is a major change to the way VAT’s collected in the building and construction industry and will affect both suppliers and customers that are both VAT and CIS registered. The changes means the supplier will no longer charge VAT on its specified supplies. The customer receiving the supplies will be responsible for accounting for and paying any VAT due to HMRC. The new legislation only applies to VAT-registered businesses who are supplying/receiving standard or reduced rated services that are reported under CIS. In other words, it applies to services supplied between the majority of construction sub-contractors and contractors in the UK.

3. What construction services does the VAT reverse charge apply to?

According to HMRC, 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. This is different to the CIS scheme, which doesn’t cover materials.  Remember if the reverse charge doesn’t apply to your purchases, the VAT incurred is still recoverable under normal rules.

4. What’s exempt from the VAT reverse charge for construction services?

The reverse charge doesn’t apply if the service is zero rated for VAT or if the customer isn’t registered for VAT in the UK. It also doesn’t apply to some other services and services supplied to end users or intermediaries connected with end users.

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 tunneling 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.

5. What differences are there between CIS and the Reverse Charge?

The reverse charge will affect supplies of building and construction services supplied at the standard or reduced rates of VAT which also need to be reported under CIS. HMRC define these supplies as ‘specified supplies’. There’s an important difference however, between CIS and the reverse charge where materials are concerned. The reverse charge will apply to the whole invoice, including service and materials content. If any of the services in a supply are subject to the reverse charge, all other services (even if that service would be excluded if it were being supplied as a single service) will also be subject to it. If there’s any doubt whether a type of works falls within the definition of a specified service, as long as the recipient’s VAT registered and the payments are subject to CIS, the reverse charge should apply.

6. How will the domestic reverse charge work in practice?

The reverse charge means the customer receiving the specified service has to account for the VAT instead of the supplier. The supplier won’t charge VAT on its invoice. In turn the customer can recover the VAT, subject to the normal rules for VAT recovery. This is likely to result in a nil net effect on the customer’s VAT return. Most accounting packages should be able to deal with the reverse charge transactions by posting to a specific tax code.

7. As a supplier, how will the domestic reverse charge affect me?

If you’re a supplier, you’ll no longer charge VAT on your ‘specified supplies’ to VAT registered customers. Suppliers may find that because they no longer pay the VAT on some of their sales to HMRC, they become repayment traders, for example, claim VAT refunds from HMRC. Suppliers should consider changing their VAT returns from quarterly to monthly to speed up payments due from HMRC.
Remember it’s perfectly possible for you to have to apply reverse charge to only some of your purchases and to some of your sales. If reverse charge doesn’t apply, normal VAT accounting will still be used. This means you may find your VAT cashflow’s impacted. It’s essential to check if overall, you’d be better or worse off filing monthly or quarterly VAT returns.

8. What if I’m invoicing for mixed supplies that includes a VAT reverse charge component?

In this case, you should normally apply the VAT reverse charge for the whole invoice. This is intended to make the system as simple as possible to administer. HMRC will allow you to disregard the reverse charge component if there’s a true mixed supply and the reverse charge part is ‘5% or less’.  However, we recommend you take advice on how to apply this if relevant because the rule doesn’t apply where there’s a single supply for VAT purposes (even if you believe part of the supply could be carved out or apportioned on a cost basis).

9. What are end users and intermediary supplier businesses?

The reverse charge doesn’t apply to consumers or final customers i.e. those that don’t make onward supplies of the building and construction services. These are end users. Any end users who are registered for VAT and CIS will need to ensure their suppliers don’t apply the reverse charge on services supplied to them by issuing a declaration of end user status. Intermediary suppliers are VAT and CIS registered businesses that make onward supplies of construction services to end users they’re connected or linked to. An intermediary supplier can also be treated as if it were an end user. To be connected or linked to an end user, intermediary suppliers must either share an interest in the same land where the construction works are taking place or be part of the same corporate group.

10. What checks will I have to do on my customers or end users?

We recommend you check the status of your customers and keep a record for all contracts. For businesses that often deal with end users, a practical way of dealing with the question of end user status is for the business to include a statement in their terms and conditions to say they’ll assume their customer’s an end user unless they state otherwise. This places a responsibility on the customer to respond if this isn’t the case.

11. How can I verify the VAT status of my customers?

Before you can apply the reverse charge, you need to be satisfied your customer’s VAT registered. You can check that your customer’s VAT number is valid and belongs to them by using HMRC’s ‘VAT Checker’ – click here.

12. How can I verify the CIS registration of my customers?

You should ask new customers to provide details of their registration as a contractor for CIS purposes, or a copy of their CIS verification, and retain these.  You can also check CIS status if you have the relevant details by using the HMRC website – click here.

13. How do the new VAT rules compare to the current VAT rules?

The current VAT rules are those of any typical supply chain.

For example, a subcontractor invoices £1,000 plus VAT of £200 to a contractor. The contractor would pay £1,200 to the subcontractor (ignoring CIS tax).

Subcontractor VAT return:
The subcontractor would therefore include in Box 1 the VAT amount of £200. Assuming no other transactions the subcontractor would pay £200 to HMRC.

Contractor VAT return:
The contractor would therefore include in Box 4 the VAT amount of £200. Assuming no other transactions the contractor would reclaim £200 from HMRC.

NOTE: Under current rules, HMRC would lose out by £200 if the subcontractor was a fraudulent missing trader.

Using the simple example above from 1^st March 2021 the following would apply.

The subcontractor would invoice £1,000 but state reverse charge VAT rules apply. The contractor would pay £1,000 to the subcontractor (ignoring CIS tax).

Subcontractor VAT return:
The subcontractor would therefore include in Box 1 a VAT amount of £Nil. They would still declare the net sale of £1,000 in Box 6 of the VAT return. Assuming no other transactions the subcontractor would not pay anything to HMRC.

Contractor VAT return:
The contractor must account for the reverse charge on its VAT return. Therefore they include it as a sale in Box 1 of their VAT return £200 and an input recovery amount of £200 in Box 4. As a result the contractor also would not pay or receive anything from HMRC.

NOTE: Under the new rules the subcontractor does not receive the £200 VAT from the customer. Therefore the missing trader fraud suffered by HMRC is avoided.

14. What questions must I ask myself to decide whether ‘Normal VAT’ applies or ‘VAT Reverse Charge’?

The subcontractor must answer these 5 questions:

1. Are any of the supplies made within the scope of CIS?
2. Is the supply standard rated or reduced rated?
3. Is your customer VAT registered?
4. Will your payment be reported under CIS?

Answering ‘No’ to ANY of the above means that ‘Normal VAT’ rules apply.

5. Has your customer confirmed that they are an ‘end user’?

Answering ‘Yes’ to question 5 also means that ‘Normal VAT’ rules apply.

The ‘reverse charge’ applies for all remaining scenarios. That’s to say the answer is ‘Yes’ to ALL of the first 4 questions and the customer is NOT the end user.

15. Will the VAT Reverse Charge affect other VAT schemes?

YES, it will affect other VAT schemes. Businesses on either the Flat Rate Scheme or Cash Accounting may no longer be available or beneficial under the new rules.

Flat Rate Scheme

Reverse charge supplies aren’t 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 to them bearing in mind that under the scheme they can’t recover VAT incurred on purchases of materials, overheads and so on.

Cash accounting scheme

You can’t use the VAT Cash Accounting Scheme for supplies of services that are subject to the VAT reverse charge.

16. VAT Reverse Charge for construction – Monthly or Quarterly VAT returns?

Subcontractors may find themselves in the unusual position of not having to charge VAT on most of their sales. As a result, they may become repayment traders. This is where they typically receive a repayment from HMRC on their VAT returns.

VAT repayments may become due following the VAT reverse charge for construction industry businesses. As a result, we’d recommend businesses explore if it’s beneficial to move to monthly VAT filings. This should speed up the repayments due from HMRC.

For other businesses, such as main contractors with a mix of zero-rated, reduced rate or standard rated sales, it might be beneficial to move from monthly VAT returns to quarterly VAT returns.  This could be because many of their subcontractors will no longer be charging VAT if the reverse charge applies. Clearly, this will depend on their specific circumstances and the mix of purchases and sales.

To change to filing monthly VAT returns (or from monthly to quarterly), the request can be made on-line, via the HMRC on-line portal. HMRC will normally approve the change relatively quickly.  However, allow enough time for the request to be processed if you wish to move from the start of your next VAT return period.

17. What if my construction project begins before Monday 1 March, but ends after the legislation comes into effect?

It will depend upon when the tax point is. In most cases, this will be the date of issue of the VAT invoice, or the receipt of payment – whichever occurs first.

If the tax point’s on or after 1 March 2021, then the reverse charge should be applied. If the tax point’s before that date, current VAT rules apply.

There are special transitional rules for authenticated tax receipts and self-billed invoices.  HMRC will allow the date of the document to determine whether it falls under normal VAT accounting (eg before 1 March 2021) except where payment’s delayed until after 31 May 2021.

18. What VAT rates does the VAT reverse charge for construction services apply to?

It applies to both standard and reduced-rate VAT supplies. It doesn’t apply to zero-rated.

19. I’m a sub-contractor. What does the VAT reverse charge for construction services mean for my business?

If you’re a sub-contractor (i.e. you supply CIS-regulated construction services), then you’ll need to consider the impact of the reverse charge on your cash flow and how to make any changes to comply with the administration of the new rules. When it comes to completing your VAT return, you must not enter in Box 1 of the VAT return any output tax on sales to which the domestic reverse charge applies. But you must enter the value of such sales in Box 6. Remember reverse charge can apply to some of your purchases from other suppliers as well as to your sales – so it’s necessary to check if reverse charge applies to your purchases.

20. I’m a contractor. What does the VAT reverse charge for construction services mean for my business?

If you’re a contractor (i.e. purchase CIS regulated construction services) then you need to ensure that when you receive reverse charge VAT invoices you correctly account for them. This may require an update to your accounting software if you do not use cloud software.

You may gain a cash flow benefit because the VAT you previously had to pay when paying sub-contractors, but could not reclaim until your next VAT return, is simply netted off in your VAT return. There should be no net impact on your overall VAT bill.

However, to ensure you don’t pay too much or too little VAT, make sure the invoice you receive is correct, especially with regard to the correct VAT rates, and ensure the services listed are eligible for the reverse charge.

When it comes to your VAT return, enter in Box 1 of the VAT return the output tax on purchases to which the domestic reverse charge applies. You may reclaim the input tax on your domestic reverse charge purchases in Box 4 of the VAT return under the normal rules.  The necessary statistical entries will need to be made in Box 6 and 7, as appropriate, in the normal way.

21. Does the VAT reverse charge for construction services apply to work provided for home/domestic users?

NO. It only applies to VAT-registered businesses registered for the CIS. If the services are provided for non-VAT-registered individuals or other kinds of ordinary non-business individuals, then standard VAT rules apply.

22. Does the VAT reverse charge for construction services apply to work undertaken overseas by my company?

NO. It’s limited to UK companies providing construction services within the UK to VAT registered customers

23. What wording needs to be stated on invoices should the VAT reverse charge apply?

The invoice must state that reverse charge applies. The HMRC example is as follows: ‘Reverse charge: VAT Act 1994 Section 55A applies’

24. Are there any ways to reduce the negative impact of the cash flow ‘pinch’ that many are expecting?

The cashflow consequences on smaller subcontractors could be a major issue if  they’re not mitigated. If this is a potential problem for your business, you must consider your options. These could include:

• What VAT scheme you are on? – Cash Accounting and Flat Rate are unlikely to be available or beneficial under the new rules.
• Changing from net subcontractor status to gross status, ensuring higher payments are received from customers.
• Discussing payment terms with customers.
• Delaying capital expenditure until 2021 – 2022, when impact on cashflow’s better understood.
• Changing to monthly VAT returns if the business becomes a repayment trader.

 For example a subcontractor invoices £5,000 plus VAT on 1 February 2021. The money’s received from the customer on the same day. Assuming a VAT quarter of 30 April 2021, the £1,000 VAT isn’t paid over to HMRC until 7 June 2021. The £1,000 is therefore a source of capital for the subcontractor for over 4 months. A repeat transaction on the 1^st March 2021 won’t include the additional £1,000 VAT, therefore reducing available cashflow.

25. What are the risks if I get this wrong?

HMRC say they will apply a ‘light touch’ for six months to 1 September 2021, provided you’re trying to comply. It’s therefore important you can document the steps you’ve taken to prepare for the change.

However, the issues run much deeper than what HMRC may do:

• • Angry customers if you charge VAT incorrectly and HMRC refuse to allow recovery.
  • Disruption to payments if suppliers/customers are arguing about whether the reverse charge applies to them or you.
  • HMRC assessment if you fail to apply VAT where it’s due.
  • HMRC delaying VAT refunds while they check you and your suppliers have applied reverse charge correctly and VAT has been correctly accounted for.

 

Disclaimer

This content provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.