The scheme’s implementation has been delayed twice, but HMRC is writing to affected businesses now with confirmation that they intend the legislation to be introduced. The move is the latest in a series of HMRC initiatives to tackle VAT fraud, estimated to cost the UK billions of pounds every year.
So what is the reverse charge, and how will it affect construction businesses?
What is the reverse charge VAT mechanism?
The reverse charge mechanism is HMRC’s way of trying to tackle the problem of ‘vanishing tradesmen’ – suppliers who charge and collect VAT for their services, but then disappear before they ever pass it on to HMRC.
Under the new regime, a VAT-registered business supplying construction services to another VAT-registered business will have to issue a VAT invoice stating that the service is subject to the reverse charge. Rather than paying any VAT to that supplier, the company receiving those services will need to account for the VAT on that supply itself through its VAT return; it can then recover the VAT as input tax, subject to the standard rules.
What does it mean in practice?
If you own a construction development company and hire other suppliers – such as bricklayers, plasterers, and painters and decorators – you will no longer leave them to charge or declare and pay any VAT that you’ve paid them for their services. Instead, as of March 2021, you will effectively charge your own business the VAT on these services, and pass it directly to HMRC on the same VAT return as you recover input tax on the supply.
The reverse charge applies through the supply chain until supplies are made to the “end-user” of the services; the “end-user” is not making an onward supply of construction services. Originally HMRC intended for the supplier to apply the reverse charge based on its own checks of the customer’s status, but this was changed in July 2020. The customer is now responsible for notifying the supplier in writing that they are the “end-user”.
In HMRC correspondence, they have confirmed there is an option for the customer to elect to be the end-user or not through this notification process. If the end-user does not want the reverse charge to apply, they can use this option to become the end-user. However, if they don’t notify the supply of its end-user status, the reverse charge will then be applied. This is likely to result in a cash flow benefit for customers who will not need to pay the suppliers the VAT due on construction services. The VAT is accounted for in the VAT return under the reverse charge mechanism.
On the other hand, suppliers will want to charge VAT on their invoices as the application of the reverse charge will reduce the gross amount invoiced to customers.
We, therefore, expect some difficult discussions between main contractors and sub-contractors as to whether VAT is chargeable on the subcontractor’s supplies or not. Sub-contractors should be initiating those discussions as soon as possible to ensure that all parties understand whether VAT is charged or not.
Will your construction business be affected by reverse charged VAT?
The VAT reverse charge mechanism is due to apply to the same range of construction services currently covered by the Construction Industry Scheme. It also only applies to those specified services supplied to another construction business, which will, in turn, sell on those services.
If, for example, you employ a builder to extend your property, the reverse charge is not an issue for you. But if you are a house builder or main contractor who hires other specialist trades such as roofers or electricians to help you complete extensions for clients, the reverse charge will likely affect you, and you need to consider whether to make the end-user notification to your suppliers or not.
Which supplies are affected by reverse charge VAT?
The reverse charge VAT mechanism will cover the following services:
- Construction, alteration, repair, extension, demolition or dismantling of buildings or structures (whether permanent or not), including offshore installations
- Construction, alteration, repair, extension or demolition of any works forming, or to form, part of the land, including walls, roadworks, power-lines, electronic communications apparatus, aircraft runways, docks and harbours, railways, inland waterways, pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence
- Installation in any building or structure of systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection
- Internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration
- Painting or decorating the internal or external surfaces of any building or structure
- Services related to the above, including site clearance, earthmoving, excavation, tunnelling and boring, laying foundations, erecting scaffolding, site restoration, landscaping, and the provision of roadways and other access works.
The reverse charge mechanism only applies to supplies of construction services which are subject to the standard rate or reduced rate of VAT.
What supplies are excluded?
The following services are not included in the definition of construction services:
- Drilling for, or extraction of, oil or natural gas
- Extraction of minerals and tunnelling or boring, or construction of underground works, for this purpose
- Manufacture of building or engineering components or equipment, materials, plant or machinery, or delivery of any of these things to a site
- Manufacture of components for systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection, or delivery of any of these things to a site
- The professional work of architects or surveyors, or consultants in building, engineering, interior or exterior decoration, or in the layout of landscape
- The making, installation and repair of artistic works, such as sculptures, murals and other works which are wholly artistic in nature
- Signwriting and erecting, installing and repairing signboards and advertisements
- Installing seating, blinds and shutters
- Installing security systems, including burglar alarms, closed-circuit television and public address systems.
What do you need to do?
If you supply any of the services listed above that will be affected by the introduction of the reverse charge VAT mechanism, it’s important to understand how the measure might impact on your business operation. HMRC has already accepted that the impact on the industry is potentially significant; construction companies will have to adapt their accounting systems to process reverse charge supplies correctly and ensure that supplies and purchases are correctly treated. Some businesses may also see significant variation in cash flow, as they will no longer be able to use VAT collected from customers as working capital before paying it on to HMRC.
This post was produced by Dougie Todd, Tax Partner at Price Bailey. To contact Dougie about any of the points raised in this article or understand how the scheme will directly impact your business, please get in touch using the form below.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.
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