Preparing for the Construction VAT Reverse Charge
There’s a major change coming to the construction sector in a month’s time. From 1 March this year, HMRC will introduce its delayed ‘VAT Reverse Charge’. The change was scheduled to come into effect in October 2020, but the disruption caused by the pandemic forced ministers to delay.
The extra time to prepare was welcomed by many, but with the date fast approaching, those who work in the industry need to make sure they’re set up for the change. Below we go through what you need to know and how you can be confident you won’t be caught out and fined.
Suppliers in the construction industry, from bricklayers to window glaziers, manage their VAT payments by charging their customers upfront with VAT included. Suppliers then pay the total VAT levied across all their invoices in a single payment, once a quarter.
The change has been brought in as an attempt by the Treasury to avoid ‘missing trader fraud’ when subcontractors charge VAT to their customers, but then fail to pay it back to the HMRC. This is a substantial tax loss, and it’s estimated that HMRC misses out on nearly £100 million a year. There are currently 100,000 - 150,000 businesses that will be affected by the change.
Contractors will now declare VAT due on services or goods they purchase as output tax on their VAT return. They can reclaim it under normal rules by using the reverse charge mechanism. The government website has detailed explanations of how this charge works and how to apply it in their Technical Guide. There are, however, many exceptions to the charge.
Construction Industry Scheme registered contractors and sub-contractors
The charge only applies to customers registered for the Construction Industry Scheme (CIS). So, both parties will need to establish if either is part of the CIS before working out how to bill and pay VAT. Under the CIS, a contractor pays VAT directly to HMRC from a subcontractor’s payment. Payments that aren’t reported under CIS won’t have any changes applied. There’s special guidance on the government website that outlines the duties of both contractors and subcontractors in the Construction Industry Scheme.
Standard and reduced rate supplies
Standard and reduced rate supplies count in the scheme but anything zero-rated does not.
Supplies for non-end users
A significant exemption lies in which point of the process supplies are purchased for. Any goods or services that are made to the final customer will be excluded, but supplies prepared for anyone earlier in the process are not. So, now customers will have to confirm with their suppliers and subcontractors whether they’re the end-user of the services.
Some other exemptions include the manufacture of components for systems of:
- heating, lighting, air conditioning and ventilation
- power supply, drainage, sanitation, water supply and fire protection.
And the installation of:
- seating, blinds and shutters
- security systems, including burglar alarms, closed-circuit television and public address systems.
You can find an exhaustive list of when not to apply the reverse charge to goods and services here. Even though some supplies may not be subject to the reverse charge, if any good or service included does fall under the reverse charge, the whole supply is affected.
This will affect the way many construction businesses and sole traders do their accounting. Not only will there be more paperwork involved for customers who will need to pay VAT on many of the goods they buy, but the working capital of both suppliers and customers will be impacted too.
Short-term working capital impact
Under the current system, a supplier charges VAT to their customer and has the option to use the funds as short-term working capital, before later settling the outstanding VAT liability with HMRC as part of their quarterly tax returns. Now, many firms will have to foot the costs of purchasing raw materials from their own cash reserves.
And it’s not just suppliers who will feel the increased admin heaped on them. Customers paying for services will also need to check the VAT they’ve been charged is correct. And they need to make sure they’re able to pay for the VAT due. Overpaid VAT won’t be reimbursed and undercharging will be met with penalties. It’s important that both parties stay on top of all purchases.
Make sure communication between contractors and subcontractors is clear. It’s up to the individual to make sure VAT is charged properly.. Given the delay in introducing the change, HMRC is likely to enforce these changes strictly.
Set up for success
For every job you undertake, make sure you know if you’re supplying the end-user or a third party. Suppliers will also need to establish that their customer is VAT registered. Ask in advance if the reverse charge applies, and check your customers’ VAT and CIS status yourself. Invoice templates will have to comply with the new HMRC guidance.
Upgrade your software
Accounting systems and software need to be able to manage with the reverse charge. Anyone responsible for VAT accounting must be familiar with the reverse charge and confident about what processes need to be in place. Day-to-day VAT decisions should be logged in a systematic way so all reasoning behind VAT charges is obvious, in case there are any issues with HMRC.
Cash flow facilities
The way subcontractors and the like manage their cash flow will have to change. If you’re a supplier or subcontractor, do you rely on using the upfront VAT payments you receive from customers as part of your working capital? Will you be able to manage not receiving the VAT portion of your invoice instead of paying a larger one-off sum later on?
If you think you’ll be affected by the reverse charge then talk to us about your cash flow concerns. We may be able to help you unlock the cash tied up in unpaid invoices. Our CBILS revolving credit facility is like an advance on long payments.
The most important thing is to keep communication open. Make sure you’re upfront and clear with customers and suppliers. You want to make sure everyone is paying or applying the correct VAT. Getting confirmation from your customers that they are the final user isn’t something your accountant can control for you. It’s crucial that you’re on top of your internal processes to make sure the external tax advice they give is accurate and serves you effectively.
This information is general and we always advise speaking to your accountant if you have any specific questions.