◾ What are the Reverse Charge rules?
◾ To whom do the Reverse Charge rules apply to?
◾ When do the Reverse Charge rules change?
The VAT ‘reverse charge’ for the construction industry, which will affect many VAT-registered construction businesses, was originally due to be introduced on 1 October 2019, but was then postponed.
They will now come into force on 1 March 2022.
These will affect any VAT-registered construction business that does the following:
- Buys in construction services from other builders or related trades and makes an onward supply of those services to another customer (eg where a subcontractor may invoice you as the main contractor on a project, and you invoice the final ‘end-user’ customer).
- Sells construction services to other builders where the builders make an onward supply of the services to their customer (eg you invoice another builder who in turn invoices the ‘end user’ customer).
What is changing?
Under current rules, a VAT registered builder 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 within the construction industry. The subcontractor ‘builder’ will invoice their main builder customer without charging VAT and the builder customer makes the Box 1 entry instead on their own VAT return.
In effect, there will be no cash flow issue for the main builder receiving services from the subcontractor builder 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.
Why is it changing?
These VAT reverse charge measures for the construction industry are being introduced by HMRC to reduce what’s often termed as ‘missing trader’ VAT fraud.
HMRC has identified that certain builder supplies have been prone to VAT fraud, where the supplier charges VAT to his customer, receives money for this VAT from the customer but never declares it on a VAT return. The new procedures aim to prevent this from happening because the supplier is never paid VAT in the first place.
Which sales are caught by the new rules?
The new construction industry VAT reverse charge procedures will apply to the following transactions:
- The legislation refers to “specified services” between businesses within the construction industry. A list of such services which are included or excluded is included below (click here).
- The reverse charge will also apply to any goods supplied by the builder as part of their work;
- Employment businesses are excluded from the new rules;
- The reverse charge is based on the rate of VAT that applies for the work in question but only supplies subject to either 5% or 20% VAT. Zero-rated sales are excluded.
Mike is an electrician, VAT registered as a sole trader. He is doing some work on an office block, invoicing the main contractor, Steve, for his work.
Steve is also VAT registered, and will then invoice the building owner. Steve is not an “end-user” because he is making an onward supply of construction services to his own customer. He is an “intermediary supplier”.
The invoice raised by Mike will be subject to the new procedures, i.e. no VAT is charged. Let’s say the value of his work including materials will be £5,000:
Mike’s VAT return will only include the value of the sale in Box 6 (outputs) of his VAT return:
- Box 6 – outputs – £5,000
Steve 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 Steve)
Other issues to consider
Taking the Steve and Mike example a stage further, they each have their own responsibilities with the new rules.
Mike must ensure that Steve is both registered for CIS (Construction Industry Scheme) and also has a valid VAT number. This is usually what happens the other way round for Steve checking Mike as he must verify him with HMRC and deduct appropriate CIS tax rates before being able to pay him. But from 1st March 2021 Mike has more VAT duties.
Mike must also specify on his sales invoices the amount and rate of VAT that Steve must declare with the reverse charge ie 5% or 20% VAT.
Mike should include wording on the sales invoice along the lines of: “Reverse charge: customer to pay the VAT to HMRC.”
Steve must tell Mike if he is an “end-user” or “intermediary supplier” in the context of the work being invoiced by Mike. If he is an intermediary supplier, then Mike will not charge him VAT because the reverse charge applies. If Steve is the end-user (ie Steve needs the work for himself or his business only) then Mike will charge VAT as Steve is not selling on to another end user.
It is important that Steve does not pay VAT incorrectly to Mike because HMRC could raise an assessment for the VAT that he should have declared, ie as if the reverse charge had been done correctly.
Additional points to consider for the VAT reverse charge for the construction industry:
- Checks should be applied to ensure building contractor clients invoiced under the new rules are properly registered for VAT and are bona fide. Section 9 of HMRC VAT Notice 735: Domestic reverse charge procedure gives further information.
- HMRC suggests that if there are any doubts about the credentials of a builder customer, then a deposit equal to the amount of VAT not being charged should be collected from the customer e.g. if they have applied for but not received a VAT number.
- VAT Notice 735 mentioned above gives examples of customer checks that should be considered such as:
- commercial checks on creditworthiness and customer status do they suggest any reason to doubt your customer’s credentials.
- is the VAT registration number genuine and does it belong to the person who is quoting it? You can contact VAT general enquiries to check (large businesses can contact their Customer Relationship Manager for advice).
- is this a new customer or a well-established business known to you? In general there is no need for you to carry out special verification of the VAT registration numbers of existing customers who you have an established trading relationship with.
- have you any grounds to doubt the credentials of your customer?
- are there features or circumstances that are out of the ordinary in respect of the transaction? If so, establish the reasons are credible.
You should keep evidence of the checks you’ve performed, so they can be shown to HMRC if asked.
Penalties issued by HMRC for errors
It is unclear how HMRC will be applying penalties for failure to implement this correctly. We believe there may be a “light touch” approach in the first six months, particularly if businesses have made every effort to apply the rules correctly.
Detailed HMRC guidance on the reverse charge for building and construction services was issued in June 2019.
The latest update to this guidance encourages traders to:
- check whether the reverse charge affects either sales, purchases or both;
- make sure accounting systems and software are updated to deal with the reverse charge;
- consider whether the change will have an impact on cash flow; and,
- make sure all staff and/or subcontracted bookkeepers who are responsible for VAT accounting are familiar with the reverse charge and how it will operate.
Hopefully this update gives you an idea of the key issues to bear in mind regarding the VAT reverse charge for the construction industry; further general information is available directly from the HMRC here, plus a full technical guide here.
Services affected by the VAT reverse charge for building and construction services
You will have to apply the reverse charge if you supply any of these services:
- constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services
- constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, including (in particular) walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours
- pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence
- installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure
- 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 inside or the external surfaces of any building or structure
- services which form an integral part of, or are part of the preparation or completion of the services described above – including site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works
Services excluded from the VAT reverse charge for building and construction services
The following services are not subject to the reverse charge:
- drilling for, or extracting, oil or natural gas
- extracting minerals (using underground or surface working) and tunnelling, boring, or construction of underground works, for this purpose
- manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site
- manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to site
- the professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants
- making, installing and repairing art works such as sculptures, murals and other items that are purely artistic
- signwriting and erecting, installing and repairing signboards and advertisements
- installing seating, blinds and shutters
- installing security systems, including burglar alarms, closed circuit television and public address systems