A 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 from 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 that 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, 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 the 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:
- The work comes under the scope of CIS
- Both businesses are VAT registered
- VAT is chargeable at either 5% or 20%
- The business receiving the supply is making an onward supply to another customer.
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.”
When does the reverse charge not apply?
- If the contractor works for an end user. It is the responsibility of the end user to inform the contractor of this and the reverse charge will then not apply. The contractor will need to charge VAT as normal. An end user is one who is not making an onward supply of construction services.
- If there is a link or a connection between the contractor and an end user. In these cases, the parties are treated as one and supplies made will be subject to the normal rules. This will apply if the parties are part of the same corporate group or if they have the same interest in the land where the building work is taking place, for example, landlord and tenant.
- If the customer is not VAT registered. The reverse charge should not be applied, and the supplier should charge standard VAT as normal. Use the HMRC VAT checker to ensure the registration is valid: VAT registration checker
- If the customer is an individual. The reverse charge does not apply to supplies to non-business individuals.
- If the work is carried out overseas. The reverse charge only applies to UK suppliers, supplying UK customers.
- If the work is zero-rated or exempt. For example residential housing.
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 numbers 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
- date of issue of the invoice, and
- receipt of payment
The transitional rules state that for invoices issued:
- before 1 March 2021 paid on or before 31 May 2021, apply the normal VAT rules;
- before 1 March 2021 paid on or after 1 June 2021, apply the reverse charge;
- on or after 1 March 2021, reverse charge rules.
If a prepayment has been made the date of supply will be the date of payment.
Will this affect your cash flow?
Suppliers (sub-contractors) will no longer be collecting VAT from their customers on reverse charge sales, which could impact their cash flow. 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
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
Box 7 – enter the net value of the purchase, as normal
Box 1 – nothing to be entered
Box 6 – enter the net value of the sale, as normal
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.
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 businesses 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 fixed 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 has 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.