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VAT reverse charge – new rules to impact construction businesses

New rules are being introduced on 1st October 2020 which affect VAT registered construction businesses that, broadly speaking, contract with each other during the construction process, for example where a subcontractor invoices the main contractor on a project, and the main contractor invoices the final “end-user” client.

What is changing?

Under current rules a builder charges VAT to their customer; collects the VAT from the customer; and accounts for this in Box 1 on their relevant VAT return. This procedure is changing for supplies between VAT registered builders caught by the new rules.

From 1st October 2020, if the new rules apply, the builder will now invoice their customer without charging VAT, and the customer will instead make the Box 1 entry on their own VAT return.

There will be no cashflow issue for the builder receiving the services because the same amount of VAT declared in Box 1 will also be included as input tax in Box 4. This is known as a “reverse charge” procedure. Cashflow issues may ensue for the sub-contractor, but this can potentially be mitigated by moving over to monthly VAT return filings (see below).

Which sales are caught by the new rules?

The new reverse charge procedures will apply to the following transactions:

The reverse charge only affects supplies between VAT registered businesses.

The reverse charge only affects the provision of “specified services”, which broadly speaking are those falling under the Construction Industry Scheme. If the invoice contains a mixture of CIS and non-CIS work, then the whole invoice is caught under the new reverse charge rules.

The reverse charge is applicable to the supply of any goods as part of the work.

The reverse charge is based on the rate of VAT that applies for the work in question, but only supplies subject to either 5% or 20% VAT. Zero-rated sales are excluded.

The reverse charge does not apply to services supplied to non-construction businesses, such as a retailer having their premises improved or a private homeowner wanting an extension built.

So, if services are being provided to non-building contractor end customers, the new rules won’t apply.

The new procedures are best illustrated by way of an example:

Bob is a VAT registered sole trader electrician. He is doing some work on an office block, invoicing the main building contractor (Bill) for his work.

Bill is also VAT registered and will invoice the building owner. Bill is not an “end-user” because he is making an onward supply of construction services to his own customer (i.e. the end-user). Bill is an “intermediary supplier”.

The invoice raised by Bob will be subject to the new procedures (i.e. no VAT is charged). If the value of Bob’s work including materials is £5,000:

Bob’s VAT return will only include the value of the sale in Box 6 (outputs) of his VAT return:

Box 6 – Outputs – £5,000
Bill will undertake the reverse charge calculation on his own VAT return and make the following entries on his return:

Box 1 – output tax £1,000 (i.e. £5,000 x 20%).
Box 4 – input tax – £1,000 (same figure as Box 1) {Provided business not partially exempt}
Box 7 – inputs – £5,000 (net value of payment made to Bob).

Other issues to consider:

Taking the above example a stage further, they each have their own responsibilities under the new rules:

Bob must ensure that Bill is both registered for the Construction Industry Scheme (CIS) and also has a valid VAT number.
Bob must also specify on his sales invoices the amount and rate of VAT that Bill must declare through the reverse charge (i.e. 5% or 20% VAT).

Bob should include wording on the sales invoice along the lines of:

“Reverse charge: Customer to pay the VAT to HMRC.”

Bill must tell Bob if he is an “end-user” or “intermediary supplier”. If he is an intermediary supplier, then Bob will not charge him VAT because the reverse charge applies.

Here are a few other points to consider:

Checks should be applied to ensure building contractor clients invoiced under the new rules are properly registered for VAT.

VAT Notice 735 is HMRC’s official notice on these new rules.

Sub-contractors are likely to become VAT repayment traders under the new rules, so it is worth considering whether these businesses need to switch to monthly VAT filings to take advantage of the potential cashflow benefits.

Penalties issued by HMRC for errors:

HMRC have confirmed that penalties will not be charged for mistakes with the new procedures up until 31st March 2020, the exception being if “you are deliberately taking advantage of the measure by not accounting for it correctly.

How Hallidays can help

If you need further support with the new VAT reverse charge rules, speak to our specialist Tax team.