On 1 October 2020, the reverse charge is being introduced for certain supplies reported under the construction industry scheme. This is a potentially significant change to the way in which businesses in the construction industry account for VAT. Affected businesses should ensure that they are familiar with the new rules and take practical steps to ensure that their accounting systems can deal with the changes.
What supplies are covered by the reverse charge?
The reverse charge is relevant to all supplies of building and construction services that are reported under the CIS unless they are zero rated or provided to a customer who is not registered for VAT in the UK. Unlike the CIS, the reverse charge will apply to the whole charge and will therefore cover any materials that are included as part of the service. However, you should not apply the reverse charge if you are invoicing the ‘end user’ or an ‘intermediary’ who is connected with the ‘end-user’.
Who is the end-user?
The end user will be a CIS registered business that does not make an onward supply of the building services. They could be either a mainstream or a deemed contractor for CIS purposes and may be, for example, a public body or a business in the retail or property investment sector, although they will often be a property developer. An intermediary supplier will be connected to an end-user if they either:
- share a relevant interest in the same land where the construction works are taking place – for example a landlord and tenant, or
- are part of the same corporate group
You cannot choose whether you are an end-user or connected intermediary as it is a matter of fact. It is the customer’s responsibility to tell the supplier when they are the end-user or intermediary supplier. This should be done in writing. There is no set wording but HMRC suggest the following: We are an end-user for the purposes of s 55A VATA 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.
It may be necessary for businesses to check whether their customers are VAT and CIS registered in order to determine who the end-user is.
How does the reverse charge actually work?
Let’s take a simple scenario involving a sub-contractor supplying heating installation standard rated services to a main contractor working on the construction of a new building for the ultimate client to operate from.
The sub-contractor would currently charge VAT – it would issue an invoice to the main contractor for, say, £10,000 + £2,000 VAT. The sub-contractor would declare the £2,000 output tax to HMRC in box 1 of its VAT return. The main contractor would recover £2,000 input tax from HMRC via box 4 of its VAT return.
In the new regime, the sub-contractor would issue an invoice to the main contractor for £10,000 + £0 VAT and include wording on the invoice making it clear that the Domestic Reverse Charge applies and that the customer is responsible for accounting for the VAT. The £2,000 VAT that the customer needs to report should be shown somewhere on the invoice but not as total VAT charged in addition to the net amount. The sub-contractor would not declare any VAT on its VAT return. Instead the main contractor would report £2,000 output tax in box 1 and £2,000 input tax in box 4 on its VAT return.
So overall, the net financial effect is entirely neutral.
Both currently and in the new regime, the sub-contractor would include the £10,000 VAT exclusive amount in box 6 (net outputs) on its VAT return and the main contractor would include the £10,000 in box 7 (net inputs) on its VAT return.
As for the treatment of the supplies made by the main contractor to the ultimate client, let’s assume that the value of the contract is £2m (excluding VAT). In the current regime, the main contractor would issue invoices over a period of time totalling £2m + £400k VAT. It would declare £400k output tax to HMRC via its VAT returns and the client would recover whatever entitled to via box 4 of its VAT returns. There would be no change in the new regime provided the client makes the main contractor aware in writing that it is the end user. Otherwise, the main contractor should work on the basis that the reverse charge applies and invoice accordingly.
Is the reverse charge compatible with other VAT schemes?
Neither the cash accounting scheme nor the flat rate scheme can be used to report supplies that are within the reverse charge. Although both these schemes may still be used for supplies that are outside the reverse charges, businesses may wish to consider withdrawing from them.
Businesses who are applying the reverse charge regularly may find that they become repayment traders i.e. they are regularly reporting a net repayment position on their VAT returns. Such businesses may wish to consider switching to monthly VAT returns to improve their cash flow.