The UK government has introduced a new VAT domestic reverse charge procedure that shifts VAT liability from the Subcontractor to the Contractor from 1st March 2021.
The new rules affect companies that operate within the Construction Industry Scheme (CIS) and have an impact on VAT compliance, as well as cash flow.
By introducing the new rules, HMRC hopes to reduce ‘missing trader’ fraud, which occurs when a company sets up a construction business, charges VAT to customers and disappears (ceases trading) before tax is due, effectively pocketing money that doesn’t belong to them.
How does the reverse charge work?
With the VAT domestic reverse charge, rather than you collecting the VAT from the Contractor and paying it to HMRC on their behalf, the Contractor pays it directly to the government themselves. They may then recover the VAT amount as input tax, subject to the normal rules.
Who does the reverse charge apply to?
The VAT Reverse Charge applies for standard and reduced-rate VAT ‘specified services’ for VAT-registered individuals and businesses in the UK that operate within the Construction Industry Scheme (CIS).
If you’re a Contractor that employs Subcontractors, or a Subcontractor who is employed by Contractors, and you’re signed up to CIS, the VAT Domestic Reverse Charge will apply to you.
Construction, alteration, repairs and demolition of building structures
Civil engineering work
Heating, lighting, power, water and ventilation system installations
Prep work (e.g. site clearance, laying foundations and erecting scaffolding)
Cleaning a site after construction work
Contractors or Subcontractors whose businesses aren’t VAT registered
Work done outside of the UK
Employees and temporary workers your business is responsible for paying
*What is an end user?
End-users are individuals or businesses who use construction services for themselves and don’t sell services as part of their business. For example developers, housing associations and domestic customers.
**What are Intermediary Suppliers?
Intermediary Suppliers are VAT-registered businesses that are connected or linked to an end user. For example, a landlord and their tenant or a group of connected businesses that collaborate to purchase construction services.
How do I prepare for the Reverse Charge?
AS A CONTRACTOR
As a Contractor purchasing services, the VAT Reverse Charge means that you pay VAT to HMRC directly on your VAT return instead of paying the VAT on CIS supplies to your subcontractors.
This may mean a but of a cash flow boost because VAT previously paid to subcontractors and reclaimed on a future VAT return can be netted off.
To ensure you’re paying the right amount of VAT, make sure the invoices you receive are correct (the right amount of VAT is applied and services are eligible for the VAT Reverse Charge) and properly accounted for.
You’ll also need to ensure that all VAT and CIS registered subcontractors are aware of the VAT Domestic Reverse Charge and how VAT liability will change. It’s a good idea to contact each subcontractor individually to update them on the new rules.
If you’re taking on a new Subcontractor, you can confirm their CIS registration by sending their details to us for verification.
AS A SUBCONTRACTOR
As a Subcontractor, the Reverse Charge doesn’t make a whole lot of difference accounting wise, as you’ll simply be passing on the VAT charge you would already account for.
Where you will notice a difference is in VAT registered Contractors withholding VAT for CIS supplies, which will mean any VAT you would normally hold onto before paying it to HMRC on a quarterly return can no longer be relied upon to keep cash ticking over.
Before the Reverse Charge comes into effect on 1 March 2021, contact any CIS and VAT registered Contractors you deal with to make them aware of the changes.
Need help with invoicing?
If you’re supplying a service where the VAT Domestic Reverse Charge should be used, you’ll need to make tweaks to your invoices. A note should be added to make it clear that the Reverse Charge applies and the recipient needs to account for VAT on their VAT return. Please see question 6 in our guide for further information.
Subcontractor Stuart is hired by Contractor Colin for building work that costs £3,000 + £600 VAT. This work is a business-to-business (builder-to-builder) supply so it falls under the Reverse Charge rule.
Under the current (non Reverse Charge) rules, Stuart invoices Colin for £3,600 (£3,000 + £600 VAT) and includes the £600 on his VAT return as output tax in box 1.
Colin then claims input tax of £600 in box 4 of his VAT return and records the net expenditure of £3,000 in box 7.
Under the Reverse Charge rules:
Stuart instead invoices Colin for £3,000 and doesn’t include the £600 VAT. Instead, he adds a note that states Colin must deal with the VAT on his VAT return using the Reverse Charge.
Now, Colin has to enter the £600 VAT in box 1 of his VAT return.
So, the only change is that Stuart’s box 1 entry has shifted to Colin’s box 1 entry. HMRC still receives the correct amount of VAT.
Electrician Eric is registered for VAT, and has invoiced Contractor Ltd on 1 May 2021 for standard rated work carried out on an office block. Contractor Ltd is both CIS and VAT registered, and is making an onward supply of building services to the owner of the block. The value of labour and materials is £10,000 excluding VAT. The work is subject to the Reverse Charge Rules.
Eric records the value of the sale as £10,000, adding a note on his invoice that the amount is subject to the Reverse Charge.
The output tax of £2,000 will be added to the VAT return in box 1.
The input tax of £2,000 and the value of expense (£10,000) will also be added to the VAT return like normal.