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Domestic reverse charge for VAT on construction services

From 1 March 2021 the way VAT is collected and accounted for on transactions that come within the scope of the Construction Industry Scheme (CIS) is changing.

The changes are being introduced to combat fraud and prevent businesses charging VAT to their customers but not passing this on to HMRC. Responsibility for paying the VAT to HMRC is being pushed up the chain to the end customer.

If you are a business who supplies or receives construction services, it is important you understand when to apply the new rules. If you get it wrong, and apply the reverse charge when you should not, or do not apply it when you should, you could find yourself with a VAT liability under an assessment from HMRC.

You will also need to check that your software can deal with ‘reverse charge’ transactions. Most software providers will already have adapted their systems, and therefore issuing invoices and credit notes, and making the VAT return entries, should be relatively easy once the work has been identified as subject to the reverse charge.

What work does this apply to?

Construction services and the building and construction materials used directly in providing those services, that come within the scope of CIS. It does not apply to building and construction materials supplied independently of any services.

You can check the list of work that falls under CIS, and the work that does not, on the HMRC site here: CIS reverse charge work

What is the new ‘reverse charge’ system?

The customer will be responsible for accounting for both the sales VAT and the input VAT on their VAT return, hence no VAT will be paid or recovered.  This means that for a contractor who uses a sub-contractor, the contractor is the customer and becomes responsible for handling the VAT. The sub-contractor will receive payment for the work done, plus cost of any materials used, net of any CIS deductions, but no VAT will be received.

The sub-contractor must advise the customer that the supply is subject to the reverse charge rules.

Under what circumstances must you apply the reverse charge?

If all the following apply, you must apply the reverse charge:

HMRC adds the following guidance: “If still in doubt, provided the recipient is VAT registered and the payments are subject to CIS, it is recommended that the reverse charge should apply.”

HMRC have provided flowcharts to help:       Supplier flowchart           Customer flowchart

When does the reverse charge not apply?

Who is responsible?

The customer must take care not to accept and pay VAT on an invoice where the reverse charge should have been applied, or they could end up receiving an assessment for output VAT. Where the reverse charge has been applied, the customer must make sure they account for it properly on their VAT return.

The customer is also responsible for notifying the supplier if they are an end user or are in an intermediary supplier situation.

The HMRC example of wording to use is:

‘We are an end user for the purposes of section 55A VAT Act 1994 reverse charge for building and construction services. Please issue us with a normal VAT invoice, with VAT charged at the appropriate rate. We will not account for the reverse charge.’

The supplier must determine whether to charge VAT or not. They should obtain the customers VAT registration number and check that they are CIS registered. They should also ascertain if the customer is an end user.

If a customer has not given written confirmation that they are an end user or intermediary supplier, then the supplier must assume that the reverse charge applies.

If your customers are often end users or intermediary suppliers, you can include a statement in your terms and conditions to say you will assume they are an end user or intermediary supplier unless they say otherwise. This places a responsibility on the customer to notify in cases where the reverse charge rules apply.

When does it apply from?

The new rules start for supplies made from 1 March 2021.

Note that the cash accounting system cannot be used for reverse charge supplies. Instead, customers must use the tax point as the date of supply, which is generally the earlier of

The transitional rules state that for invoices issued:

If a prepayment has been made the date of supply will be the date of payment.

Will this affect your cashflow?

Suppliers (sub-contractors) will no longer be collecting VAT from their customers on reverse charge sales, which could impact their cashflow. It may also mean they become a repayment trader, only recovering VAT on costs, and therefore it may be beneficial to switch to monthly VAT returns.

VAT return entries for the reverse charge

Customers

Box 1 enter the output tax on the purchases that the reverse charge applies to

Box 4 enter the same amount as input tax, as normal (provided there is no restriction on recovery)

Box 6 nothing to be entered

Box7 enter the net value of the purchase, as normal

Suppliers

Box 1 nothing to be entered

Box 6 enter the net value of the sale, as normal

Invoices

The supplier should enter the usual information on their invoice, including the VAT registration number of the customer (this proves that they are a VAT registered business). It should also clearly state ‘Reverse charge – customer to pay the VAT to HMRC’.  The VAT to be accounted for by the customer, or the VAT rate, must also be shown, but it should be clear that this is not to be paid.

HMRC’s example of an invoice can be found here:  Invoice example

Suppliers using the flat rate scheme

Reverse charge sales are excluded from the flat rate scheme. Therefore, this scheme may no longer be beneficial where a supplier’s sales are mostly reverse charge sales. In these cases, it might be sensible to switch to the standard rate scheme to enable the recovery of VAT on costs.

Employment business supplying construction workers

The reverse charge rules do not apply to agencies that supply staff. This is because they are supplying staff rather than construction services.

Mixed supplies and the 5% disregard for VAT reverse charge

If you are invoicing for mixed supplies, only some of which fall under the reverse charge, you must apply the reverse charge to the whole invoice.

However, where only a minimal amount of work falls under the reverse charge, and the value of that work is 5% or less of the total amount invoiced, then the normal VAT rules should be applied to the total.

Separate contracts, invoices, or orders

Separate contracts with the same supplier for work within the scope of CIS, which are provided at the same time on the same site, will be treated as a single supply and the reverse charge will apply to both contracts.

Separate invoices for the supply and fix elements of an order that is within the scope of CIS, will be treated as a single supply and the reverse charge will apply to the full value of the order.

Separate orders placed with the same supplier for supply and fix works, which is within the scope of CIS (the first for materials and the second for labour), where the works are provided at the same time and on the same site, will be treated as a single supply and the reverse charge will apply to both orders.

Additionally, if there has already been a reverse charge service between two parties on a construction site, any subsequent construction supplies on that site between the same parties can be treated as reverse charge services if both parties agree.

 

Penalties for getting it wrong

HMRC have promised to apply a ‘light touch’ on penalties during the first 6 months, until the end of August 2021. However, you will need to be able to demonstrate that you have taken reasonable steps to apply the new rules correctly.

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