Construction VAT Changes – 1st March 2021

If you are VAT registered in the Construction Industry, then the Reverse Charge could make a massive difference to how you account for VAT.  Many of you may have heard of this term “Reverse Charge”, as the original intention was for these changes to be brought in to effect on 1 October 2019, which was subsequently put back to 1 October 2020. Due to Coronavirus this was put back even further and will now start on 1 March 2021. At the time of writing no further extension of the implementation has been announced and therefore we must assume that it will start next month on 1st March 2021.

What is the VAT Reverse Charge?

The Construction Industry, in the eyes of HM Revenue & Customs, is a major source of tax fraud. The CIS system only operates in the Construction Industry and is there to collect tax payments at source. The VAT Reverse Charge mechanism will operate so that subcontractors no longer account for, or charge VAT. In effect the contractor will now charge themselves the VAT (and be able to reclaim the same amount) and of course charges the appropriate VAT to the customer (end user). It is designed to stop VAT leakage in the construction supply chain and therefore minimise VAT losses to the Treasury. Sounds horrifically complicated? It sure is, but for the majority, once the new rules are understood (and importantly agreed between parties), it will be relatively straight forward. Once we are used to it, it will become a lot easier.

Example Reverse Charge

To help understand the implications, let us look at an example scenario:

Roofers Limited are a roofing subcontractor who are repairing a roof. They are contracted through Contractor Limited, who are managing a big set of repair works for the end Customer, Customer Limited. Contractor Limited are providing all the other construction services on the job. This example is simplistic by design

    • Roofers Limited
      • Pre reverse charge
        • Raise an invoice to Contractor Limited for £1,000
        • The job is subject to 20%, therefore they add £200 for VAT (total bill £1,200)
        • Contractor Limited pay Roofers Limited £1,200
        • Roofers Limited include in their VAT return and pay HMRC the £200 VAT
      • Post Reverse Charge
        • Raise an invoice to Contractor Limited for £1,000
        • The job is subject to 20%, but because Contractor Limited are not the end customer, Roofers Limited do not charge VAT. However, they note on their invoice that VAT is chargeable at 20% and specify the amount of VAT > Example Subcontractor Invoice
        • Contractor Limited pay Roofers Limited £1,000
        • Roofers Limited will not include any VAT on their VAT return, but will show the £1,000 as a net sale in Box 6.
      • Contractor Limited
        • Pre Reverse Charge
          • Will invoice Customer Limited as normal and declare VAT on the sale. This will be offset by purchase VAT from Roofers Limited.
        • Post Reverse Charge
          • Contractor Limited invoices the customer as normal and includes the VAT charge at 20% as normal i.e., customer will receive the same bill and pay the same VAT.
          • Contractor Limited adds the VAT on the Roofers Limited invoice to their VAT return (as additional sales VAT to pay over, £200 – Box 1) and takes it off again via an adjustment through purchase VAT (£200 Box 4). Thus, the reverse charge adjustment has no effect to Contractors Limited on their VAT bill, as it nets off to £nil.

(Nothing should be added to Box 6, but the £1,000 net expense will be added to Box 7 as normal)

Assessing if a transaction is subject to VAT Reverse Charge Rules

We accept this still sounds horrifically complicated! A lot of transactions will be outside of the Reverse Charge Rules and only if you can answer YES to these first four questions and NO to question 5, will reverse charge rules apply:

  1. Is the supply one of construction services? (see note a and b)
  2. Are both parties VAT registered? (c)
  3. Is the Supply Standard Rated (20%) or Reduced Rated (5%)? (d)
  4. Is the Supply Reportable under CIS? (e)
  5. Is your customer an End User? (f)

Notes

  1. If any of the work is construction services, no matter how small, then the whole transaction is caught by the VAT Reverse Charge Rules. You can not get around it by raising 2 invoices for a job
  2. Material only supplies are specifically excluded form the VAT Reverse Charge Rules. This includes, for example, fabrication of a staircase. As long as the staircase is not fitted on site by the subcontractor
  3. If either party is not VAT registered, then the VAT Reverse Charge Rules do not apply
  4. Zero rated jobs are outside of the VAT Reverse Charge Rules
  5. This refers to the type of supply as some supplies are outside of the scope of CIS. Whether or not the transaction is reported via CIS is irrespective and not an excuse
  6. If you are just supplying to the end user (person/body who has interest in the place where work is being carried out) then the VAT Reverse Charge Rules do not apply. This could include a person who owns or rents the property. In the case of Group Companies (complex area, sorry) a company within a Group who owns a property is also counted as the end user, even if they do not own the building themselves

Smarter Tips & Advice

These are a complex set of rules to bring into any sector and although VAT Reverse Charge Rules already exist within the VAT system, this is the first time that a common industry sector has been subjected to such VAT rules. This guide is a simple introduction. There are some pitfalls and areas to consider, along with some advice which you may find useful:

  • If you are a client of Smarter Accounting (or even if not and you want to talk to us) then call to discuss your queries and concerns. Your normal contact for VAT or Accounts will be aware of these rules and will help you make sense of what they mean for you
  • HM Revenue & Customs have already indicated that they will be lenient in the first 6 months. This is not long, but we are sure that businesses will struggle with the practicalities
  • Getting each transaction right and agreeing the treatment with your Contractor or Subcontractor is key. Both sides should be aware of this change and should apply the same determination
    • It is critical that this determination is correct following the rules outlined. You must be sure yourself that you are satisfied. If the transaction should be outside the VAT Reverse Charge Rules then you have to charge VAT. Failure to do so will mean that HM Revenue & Customs can come to you for the unpaid VAT. Similarly, paying VAT that has been invoiced to you from a subcontractor, that should not have been billed as it should have come under the VAT Reverse Charge Rules, will mean that HM Revenue & Customs could disallow that deduction in your VAT Return
  • Cashflow – We all know that cashflow is critical and cash can be tight. If you are a Subcontractor currently charging a Contractor VAT on work at present, you get the extra 20% in your bank until it is paid over to HM Revenue & Customs. You will not get this cash flow advantage going forwards
  • Flat Rate VAT Scheme – This is a specific, and some subcontractors may use the flat rate scheme (very few if any contractors will be on the Flat Rate Scheme). If this is the case, then the subcontractor preparing their VAT return cannot include the relevant sales falling under the VAT Reverse Charge Rules, and no VAT will have been charged. In addition, whilst on the flat rate scheme, you also cannot claim back input tax. Our advice would therefore be to move to standard VAT as soon as possible. Call us if you are worried about this.
  • Cash Accounting VAT – Some of you may be using cash accounting to compile VAT returns. This is very complicated in conjunction with VAT Reverse Charge Rules, and simply invoices under the new rules cannot be dealt with under cash accounting. We are not even sure that HM Revenue & Customs will accept a mixed invoice/cash accounting arrangement. It is another blow to cashflow, but our advice would be to move to standard accrual method of calculating VAT
  • Think about your contracts in advance. Discuss with subcontractors and contractors up front before you finally accept the contract. You will then know the position on the job and there may be things that can be done e.g., contracting direct with the customer
  • None of the VAT Reverse Charge Rules have any impact on the obligation to register for VAT. The threshold of £85,000 still stands and is based on total turnover, regardless of whether some of that is under the VAT Reverse Charge Rules or not
  • We have very little idea on how HM Revenue & Customs will view certain situations. In complicated areas, this will eventually come out via case law. There aren’t even any specific penalty arrangements released yet. This will be developed as we see how HM Revenue & Customs react to different situations. As always, not getting on the wrong side of them is the best policy!
  • Xero, QuickBooks, Sage and most of the accounting software providers are all advertising that they have solutions in place to cope with the contractor requirements. It remains to be seen how this works in practice. If you are not currently on any form of system, then talk to us. We can help to get you using a decent system (Xero or QuickBooks) that could make your life manageable
  • This is a horrific set of rules to have to implement for anybody. If you currently do your own bookkeeping and decide that this is a step too far for you, then we can help in a number of ways, please do talk to us!
    • We can take over all aspects of your bookkeeping, which may help us with other tax planning opportunities, and release more time for you to concentrate on your ultimate goal of expanding your business and increasing profits
    • We can provide advice on a contract by contract basis

Good luck!

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