Domestic reverse charge for VAT on construction services
The way that VAT is collected and accounted is changing as of March 20, 2021 for transactions that are in the scope the Construction Industry Scheme (CIS).
These changes were made to combat fraud and to prevent businesses from charging VAT to customers, but not passing it on to HMRC. The chain is being moved up to the customer to take responsibility for paying VAT to HMRC.
It is crucial that you know when the new rules apply to businesses that provide or receive construction services. You could be subject to a VAT assessment by HMRC if you do it wrong or apply the reverse charge incorrectly.
Also, you will need to ensure that your software is able to handle reverse charge transactions. Software providers will have already adapted their systems. This means that issuing credit notes and invoices, as well as making VAT return entries should be fairly simple once work has been identified to be subject to reverse charge.
To what work does this apply?
Construction services include the construction and building materials that are used in the provision of those services. These services fall within the scope CIS. This does not apply to building materials that are provided as a separate service.
You can view the CIS reverse charges work list and see which work falls under CIS.
What’s the new reverse charge system?
The customer is responsible for accounting both for the input VAT and sales VAT. Therefore, no VAT will ever be recovered or paid. Sub-contractors are considered customers by contractors. This means that the contractor becomes the customer for VAT. Sub-contractors will be paid for their work, as well as the cost of materials, minus any CIS deductions. However, no VAT will ever be collected.
The sub-contractor should inform the customer that reverse charges apply to the supply.
In what circumstances should you reverse charge?
If you must reverse charge the following:
- This work falls under the CIS scope
- Both are VAT registered
- VAT can be charged at either 5%, or 20%
- The supply company is making an onward supply for another customer.
HMRC also adds the following guidance. “If in doubt, provided that the recipient is VAT-registered and the payments are subjecte to CIS, it’s recommended that the reverse charges be applied.”
When is the reverse charge not applicable?
- Contractors who work for end users The end user must inform the contractor about this. Otherwise, the reverse charge will not apply. VAT will be charged by the contractor as usual. End user is a person who does not make an onward supply construction services.
- If there’s a link between the contractor or an end user. These cases will see the parties treated as one, and supplies made will follow the usual rules. This applies if the parties belong to the same corporate group, or if they share the same interest in land where building work is occurring (e.g landlord and tenant).
- If the customer has not been VAT registered. The supplier should apply standard VAT and not the reverse charge. To ensure that the registration is valid, use the HMRC VAT Checker
- If the customer is an individual. For supplies to individuals not in business, the reverse charge is not applicable.
- If the work is done overseas. Only UK suppliers are exempted from the reverse charge for supplying UK customers.
- If the work is exempt or zero-rated. Residential housing, for example.
Who are you responsible?
The customer should not accept or pay VAT on invoices where reverse charges should have been applied. Otherwise, they may be assessed for output VAT. If the reverse charge was applied, the customer should account for it on their VAT return.
If the customer is an end user, or an intermediary supplier, they must also notify the supplier.
HMRC’s example of the right wording is:
“We are an end-user for the purposes section 55A VAT Act 1994 reverse charges for building and construction services. We will be provided with a standard VAT invoice with the correct VAT rate. The reverse charge will not be accounted for.
The supplier should decide whether or not to charge VAT. They must obtain the VAT registration number of the customer and verify that they are CIS-registered. They will also need to verify if the customer has been registered as an End User.
The supplier will assume the reverse charge applies if the customer does not give written confirmation that they are end users or intermediary suppliers.
You can add a statement to your terms and conditions if your customers are end users or intermediary sellers. This will state that you assume they are end users or suppliers unless they explicitly say otherwise. The customer is responsible for notifying you if reverse charges apply.
Where does it apply?
The new rules apply to supplies that are made after 1 March 2021.
Reverse charge supplies cannot be done using the cash accounting system. Customers must instead use the date of supply as the tax point, which is usually the earlier of the two.
- Date of invoice’s issue
- Receipt of payment
These are the transitional rules for invoices that have been issued:
- The normal VAT rules apply to payments made before 1 March 2021 or after 31 May 2021.
- Pay the reverse charge if you pay before or after 1 March 2021
- Reverse charge rules apply from or after March 20, 2021.
If prepayment was made, the date supply will be the payment date.
How will this impact your cashflow?
Sub-contractors (suppliers) won’t be collecting VAT on reverse charge sales from customers. This could have an impact on their cashflow. They may become a repayment trader and only recover VAT on costs. It might be advantageous to switch to monthly VAT reports.
Entry of VAT Return Forms for the Reverse Charge
Enter the output tax for purchases to which the reverse charge applies.
Box 4 Enter the same amount of input tax as usual (subject to any recovery restrictions).
Box 6 no to be entered
Box7 Enter the purchase’s net value, as usual
Box 1 no to be entered
Box 6 Enter the net sale value, as usual
The supplier must include the usual information, including the VAT registration number for the customer. This proves that they have VAT registered businesses. The invoice should clearly state “Reverse Charge – Customer to Pay the VAT to HMRC”. It should also clearly state the customer’s VAT rate or the VAT that must be accounted for. However, it should not be payable.
HMRC’s example invoice can be found at Invoice Example
Suppliers that use the flat rate
Flat rate sales exclude reverse charge sales. This scheme is not beneficial if a supplier’s majority of sales are reverse charge. These cases may be a good reason to change to the standard rate system to recover VAT costs.
Construction workers – Employment business
Agency staff supply agencies are exempt from the reverse charge rules. They are providing staff, not construction services.
Mixed supplies and the disregard of VAT reverse charge at 5%
Invoices for mixed supplies that only one of the items falls under the reverse charges must be applied to the entire invoice.
If the work involved is minimal and less than 5% of the total invoiced amount, the reverse charge should not be applied.
Orders, bills, and contracts
Separate contracts from the same supplier for work in the scope of CIS will be treated as one supply. The reverse charge will apply to both contracts.
Separate invoices will be treated as a single supply, and the reverse charge will apply for the entire order.
Separate orders with the same supplier for supply or fix work, which falls within the scope CIS (the first is for materials and second for labour), will be treated as a single supply. The reverse charge will apply for both orders.
If there was a reverse charge between two parties at a construction site then any additional construction supplies between those parties can be considered reverse charge services.
Penalties for doing it wrong
HMRC has promised to keep penalties light for the first six months and up until August 2021. You will have to prove that you took reasonable steps to correctly apply the new rules.