The VAT Domestic Reverse Charge is a new scheme being introduced by HMRC that impacts the construction industry.
It was previously scheduled to start last year but was delayed to 1st March 2021 and according to HMRC is being brought in to try reducing fraud within the industry.
What is VAT Domestic Reverse Charge?
Effectively HMRC are changing who pays the VAT on the sale of goods and services over to HMRC for contractors and sub-contractors within the construction industry. This means the selling company no longer receives VAT from their customer and then pays this VAT to HMRC. Instead, their customer accounts for this VAT as both sale and purchase VAT on their own VAT return.
The customer would have originally paid the VAT to their subcontractor and reclaimed it through their VAT return (a net nil effect). Now, by the customer putting the VAT on their VAT return as sales and purchase VAT they achieve the same net nil effect without any cash moving.
Why is VAT Reverse Charge being introduced?
HMRC believe that there is significant potential fraud within the sector. For example, people receiving the VAT from their customers but not accounting for it on their VAT returns and paying it across to HMRC.
When do the rules become effective?
Invoices dated 1st March onward or for money received on or after 1 June 2021 but invoiced before 1 March 2021.
How do I know if I am affected?
There are 5 key questions which will advise whether you follow the normal/existing rules of VAT or the new VAT Reverse Charge rules.
What are the 5 questions?
We have created an interactive sheet you can use here which includes the questions (Click header below)
If you answer yes to a question, then move to the next question. If you answer no to any question (excluding question 5) the rules don’t apply and you account for VAT in the usual way.
We have also put some further details about each of the questions below to help you best answer them.
1) Are the supplies made to your customer within the scope of CIS?
There are certain supplies that are covered by the CIS scheme. Examples of which are below. If your supply is not within the CIS scheme answer no to this question.
Decorating, internal and external
2) Is the supply made to your customer standard or reduced rated for VAT?
In a nutshell, zero-rated supplies are not affected – for example work done on new build properties.
3) Is your customer VAT registered?
Obviously if your customer is not VAT registered, they cannot account for the reverse charge on their VAT return, so they need to continue to pay you the VAT as normal.
4) Is your customer CIS registered?
Does your customer deduct CIS tax from you or report CIS to HMRC? This applies even if you have a gross certificate. You could have the situation were as a builder you are CIS registered as a subcontractor and you do work for someone who is not CIS registered as a contractor. For example, a property management company. In this case the normal rules of VAT apply.
5) Has your customer confirmed they are the ‘end user’?
This is the only one where a no answer means that VAT Reverse Charge applies.
If you are working for a customer and they are not selling on your services then normal rules apply. i.e. an electrical contractor visits a building contractor to repair the lights in the head office. The building contractor would need to confirm they are the end user and normal VAT rules apply.
Notification of end user can be made on paper and sent by post, electronically in an email or in a contract.
If a customer has not given written confirmation of their end user status to you, you must assume that the reverse charge applies and you will not charge VAT to the customer.
If you often deal with end users, you can include a statement in your terms and conditions to say you’ll assume that your customer is an end user unless they say they’re not. This places a responsibility on the customer to respond if this is not the case and saves you admin each time.
Intermediary suppliers buy supplies from you and sell them on. If all the other questions are yes above then generally intermediary supplies will be subject to the reverse charge rules.
However, if intermediary suppliers buy construction services and re-supply them to a connected or linked end user (think group or landlord and tenant) , without making material alterations to the supplies, they’re all treated as if they’re end users and the reverse charge does not apply.
Items for consideration
There are two main areas to consider:
- The administration of the rules, for example, invoicing and accounting for the changes and;
- A cashflow problem
The administrative considerations:
The first is how to raise an invoice.
HMRC have advised there are three acceptable phrases that can be included when you raise an invoice under the new rules.
VAT Act 1994 Section 55A applies
S55A VATA 94 applies
Customer to pay the VAT to HMRC
We recommend that you use the third wording as it is the easiest to understand.
Your invoice must clearly state what amount is due to you as the supplier as well as clearly state the VAT element that the customer must account for on their VAT return and inform them that they are responsible for it.
As Making Tax Digital for VAT was introduced last year, you should be using accounting software, so it is important that you record the sale on your system correctly.
It is impossible to list all the systems and the changes being made, you will need to talk to either the software supplier (most are dealing with this new scheme, but you might need to buy some additional modules for the software) or your accountant. We have created an example below using SAGE software.
When a subcontractor – the supplier – uses tax code T21 on an invoice for their main contractor (they are producing a sales invoice), in box 6 (net sales) of the VAT return the total value of sales excluding VAT will be updated. This is because they no longer receive the VAT.
When a main contractor – the customer – (they will have a purchase invoice) uses T21 to record their purchase from the subcontractor only the net value of the purchase will be reflected in box 7 (net purchases) of the VAT Return.
The VAT value will affect boxes 1 (sales VAT) and 4 (purchase VAT) of the VAT Return. The VAT is paid and reclaimed on the same VAT Return, this is called Notional VAT.
Suppliers must not enter any output tax on sales under the reverse charge. The supplier only needs to enter the net value of the sale.
Customers must enter the VAT charged as output tax on your VAT return. Make sure you do not enter the net value of the purchase as a net sale.
The cashflow considerations
If you have to raise an invoice under the new rules you will only be paid the net amount less any CIS tax whereas before you were paid the gross amount less CIS. You can see that you will receive less cash at the point of invoice payment. If your customer paid you the day after your normal VAT return date, you would have 20% of the cash in your cashflow for a few months.
To improve cashflow, if most of your sales fall under the new rules, it might be worthwhile changing to reporting VAT monthly not quarterly, this is because you will no longer be paying money to HMRC for your sales. Your usual VAT liability will now be a refund as you will only have VAT on your purchases to reclaim.
You need to give this careful consideration and talk to your accountant, or us, to ensure it is cashflow effective.
Don’t forget this will mean you will have to do a VAT return monthly which will add to the administrative work you do and potentially the costs if a third party submits them on your behalf.
Frequently asked questions
What if I make a mistake?
HMRC have advised that they will take a soft touch approach for the first 6 months so don’t worry.
This is of course providing it is an honest mistake. If you come across an error, do try to resolve this as soon as it comes to light, as errors can be much trickier to deal with further down the line.
Do the rules still apply to me or my company if I have a gross CIS status?
In a word, yes!
What if my invoice contains mixed rate supplies?
The reverse charge is not intended to make things more complicated so if any of the services in a supply are subject to the reverse charge, all other services supplied will also be subject to it.
However, if the reverse charge part of the supply is 5% or less of the value of the whole supply, reverse charge rules can be disregarded (this is referred to the ‘5% disregard’) and normal VAT rules will apply.
How do any of the other VAT schemes work with the new rules?
The Flat Rate scheme and Cash Accounting may also cause you issues and this will need to be reviewed on an individual basis, so speak to us if you need help with this.
With the Flat Rate Scheme, reverse charge supplies are not to be accounted for and 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.
We recommend also considering if it’s still beneficial to use the Flat Rate Scheme bearing in mind that under the scheme users cannot recover VAT incurred on purchases of materials, overheads and so on.
You also cannot use the VAT Cash Accounting Scheme for supplies of services that are subject to the reverse charge.
Cash accounting will likely not be advantageous either as you no longer have any sales VAT, so if you only reclaim your purchase VAT when you pay people, you are hindering your cashflow further.
What is the benefit to my company and how can I avoid it?
Unfortunately, there are no benefits, and you cannot avoid it, if the rules apply, they apply.
What about if I construct items offsite and only install onsite?
Supply and fix works will be subject to the reverse charge because the services and goods are part of one supply for VAT purposes. For example, a joiner constructing a staircase offsite then installing it onsite, will be making a reverse charge service even if the charge for installation is only a small (subject to the 5% disregard) element of the overall charge.
In addition, if 2 parties have already had a reverse charge service between them on a construction site, for convenience they can both agree that any subsequent construction supplies on that site can be treated as reverse charge services.
What if I have two separate contracts?
If a customer enters into 2 separate contracts with the same supplier for works within the scope of CIS and the works are to be provided at the same time on the same site, the reverse charge will apply to both contracts (subject to the 5% disregard) as they comprise a single supply for VAT purposes.
What about supplies of spares?
If the original contract did not provide for the supply of spares this is a materials-only supply outside the scope of CIS – therefore, normal VAT rules apply and VAT should be charged by the supplier on the sale of spares.
If the original contract provided for the supply of spares and the original contract is subject to the reverse charge, the supply of spares will also be subject to the reverse charge and VAT should not be charged by the supplier on the sale of spares. But remember, if the original contract was to an end user the reverse charge will not apply.
What about Credit Notes?
If a supplier allows a credit to a customer who can reclaim all the tax on their supply as input tax, you do not have to adjust the original VAT charge as long as both the supplier and customer agree not to do so.
Alternatively, suppliers can issue a credit note to the customer with a note on it to show that the reverse charge applies and showing the reduction in the VAT the customer has to pay to HMRC.
Customers must then adjust the amount of output VAT due (as shown on the supplier’s credit note) by reducing the total VAT due on the VAT Return for the period in which the credit note was issued. Adjust the amount of input VAT in the same VAT Return.
Include the reduction in the value of the supply on the VAT Return for the period in which the credit note is issued.
You may find the new scheme difficult to understand and it could take time to account for correctly, especially during the first couple of months of implementation. We would like to reassure you that we are on hand should you need any part explaining in further detail or have any questions relating to the new rules.
Please call us on (01482) 888820 or email BIM@sowery-llp.co.uk