On 1st March 2021 the way to account for VAT in the construction industry will change when the domestic reverse charge (DRC) is introduced.
The reverse charge rules can be confusing. Currently a subcontractor, if they are VAT registered, issues a VAT invoice to the contractor showing the net, VAT and gross amounts. Going forward, if the relevant criteria are met, the subcontractor will no longer include VAT on their invoice. The contractor (the purchaser of the services) will account for the VAT as both VAT on sales and VAT on purchases on their VAT return.
The motivation for the legislation change is that HMRC believe that VAT fraud in the construction industry will be reduced, as, if a subcontractor does not charge VAT in the first place, and is not therefore paid VAT, he cannot pocket the VAT money and disappear without paying it to HMRC
Are you selling construction services?
If you are a builder supplying services to another business, there are five key questions to ask to decide whether you should be charging VAT or not on your sales invoices from 1st March.
If the answer to the first four questions is ‘yes’ and ‘no’ to the final question, the reverse charge will apply and VAT will not be charged on sales invoices raised for the job in question.
1. Is the work within the scope of the CIS?
Traditional building services are obviously all included under the CIS, such as electricians, plumbers, bricklayers, decorators, carpenters etc. If in doubt, refer to the HMRC guidance on the CIS. The reverse charge doesn’t apply when the supply consists only of materials. There must be an element of labour involved, but if there is and the work falls within the scope of CIS, then the reverse charge (DRC) extends to the whole invoice, including the cost of materials supplied.
2. Is the work subject to either 5% or 20% VAT?
Any zero-rated sales are excluded from the new DRC regime, e.g. construction work on new dwellings. So, if it is zero rated then there is no need to apply the DRC rules.
3. Is the customer registered for VAT?
This can be confirmed using HMRC’s new VAT number checker service. If they are not VAT registered then again, adopt normal VAT accounting.
4. Is the customer registered for the Construction Industry Scheme (CIS)?
If the answer to this question is ‘no’ you don’t need to worry about the reverse charge rules any further for this customer and can just adopt normal VAT accounting from 1 March.
5. Is the customer an end user or intermediary supplier for the work?
The DRC only applies if the customer makes an onward supply of construction services to their own customer: i.e. the typical subcontractor, contractor and customer arrangement. In cases where the contractor is not supplying on the construction services, the work is excluded from the reverse charge (DRC).
Practical issues when completing your VAT return and issuing invoices
Purchaser of the services
If you are the customer, or purchaser, of the building services, on your VAT returns the reverse charge notional VAT, i.e. the amount that would previously have been charged by the subcontractor in VAT, will appear in Box 1 and Box 4 of the VAT return, and the amount of the supply, net of VAT, will appear in Box 7 (the total purchases box) on your VAT return.
In most circumstances there is therefore no effect on your VAT return of the reverse charge invoice. The VAT liability will be the same as if the invoice had not been included on the return. You may therefore find that your VAT bills increase as you will be paying out for less VAT on the purchases that you make.
If you use software, then there should be a Domestic Reverse Charge VAT option for posting the supplier invoice on to your system. This will then automatically include the amount in Box 1, Box 4 and Box 7 of the VAT return. Please check when first processing a reverse charge invoice that your VAT return shows the invoice and reverse charge VAT correctly.
Supplier of the services
As the supplier of a reverse charge service, you will not charge VAT on your invoice, and the amount of the sale will appear in Box 6 (the total sales box) on your VAT return.
It must be clear on the invoice you supply to your customer that the customer must make a reverse charge entry, ideally specifying as a comment on the invoice the amount of VAT or at least the rate that applies to the work.
The invoice should be coded to the Domestic Reverse Charge sales heading so that it is captured on the VAT return in Box 6.
You may notice changes to your cash flow, either because you are no longer charging VAT, or you are no longer suffering VAT on your purchases. Please let us know if this will cause you an issue, and we will work with you look for any available solutions.
HMRC have issued a very good webinar if you would like further information – please follow the link below and click on the ‘Catch up webinar on the new VAT reverse charge for construction services’
There are two helpful flowcharts in HMRC’s comprehensive guidance on the new rules and when they apply – one is for suppliers and one is for buyers (see section 25 of the technical guide). They are worth downloading for future reference.
If you need any further help, please contact one of the team who will be happy to support you.