CIS reporting: VAT reverse charge extended to construction
As part of HMRC’s wider programme of combatting VAT fraud, from 1 October 2019 it is introducing a new VAT regime for the construction industry, which will have major consequences for both contractors and developers.
This new VAT regime will be a reverse charge, which will cover more than just construction services. The reverse charge will mean that the supplier no longer charges VAT to the customer, but the customer “self-accounts” for the VAT due. That is, the customer is responsible for the output tax and for deducting input tax on their own VAT return.
The new regime was first proposed in 2017, and is similar to arrangements in place for the sale of computer chips and mobile phones.
Under the new regime, a VAT-registered business, which supplies certain construction services to another VAT-registered business for onward sale, will be required to issue a sales invoice without VAT, stating that the service is subject to the domestic reverse charge. Responsibility to account for the VAT on the construction services passes to the customer, who includes the transaction as both a VATable sale, and a VATable cost on their next VAT return.
So for many customers this will mean no more than two equal and opposite book entries in their VAT account, with no money actually being paid to HMRC. However where the VAT is not wholly recoverable, perhaps because the building is used in part for an exempt activity, the customer will be obliged to pay HMRC the difference between the amount due on the full value of the construction services and the amount they can recover.
What services will it apply to?
The regime will apply to B2B supplies of those services between VAT-registered businesses where the recipient then makes an onward supply of the same construction services. It will apply to those construction services that are covered by the Construction Industry Scheme (CIS) for income tax purposes. From 1 October, the new regime will be compulsory for all qualifying supplies. There is no provision to “opt out of the regime” or obtain any form of exemption certificate from HMRC.
However, the new regime will not apply where:
- Services are supplied to the end user, such as the property owner, or directly to a main contractor that sells a newly completed building to the customer;
- The recipient makes onward supplies of those construction services to a connected company;
- The supplier and recipient are landlord and tenant or vice versa, or
- The supplies are zero-rated.
How will it affect customers, developers etc.?
When the new regime was first announced, it was generally seen as good news by many developers, as they would no longer have to fund the VAT cost of construction services while they were waiting for HMRC to make repayments.
While this is true, developers still face a number of important challenges in implementing this new reverse charge regime:
- Developers and others will need to adapt their accounting systems to process reverse charge supplies then make ongoing checks to ensure that supplies and purchases are correctly treated
- Systems will need to be put in place to deal with any contractors who continue to use “normal VAT account” in error.
- For mixed use developments (part residential part commercial), systems will need to be put in place for applying the reverse charge to part of the overall cost of construction.
- Deciding which rate of VAT to apply to particular types of construction services will now fall to the customer, rather than the supplier.
- Where the customer is the “end user”, they are required to provide their supplier with confirmation of end user status, at which point the contractor accounts for VAT under the normal rules. However, if the end user fails to issue the formal confirmation, they become responsible for accounting for the domestic reverse charge.
How will it afftect contractors?
For many contractors, the new regime will result in a potentially serious cash flow issue. As they will no longer be charging VAT on their supplies, contractors will be unable to use the VAT they collect from customers as working capital before they pay it over to HMRC. Traditionally, contractors large and small have used the VAT they are paid by customers as short-term working capital to fund their business.
With source of funds no longer available to them, many businesses are facing some difficult choices about funding their operations post 1 October 2019. Some of the more forward-thinking developers are already in discussion with their key contractors about managing these issues.
In addition, to determine whether the reverse charge applies, it will be necessary for contractors to disclose to their subcontractor whether or not they are at the end of the supply chain – information which could, in some cases, be commercially sensitive.
What actions should be taken?
Construction businesses should:
- Review supplies made to and received from other VAT registered contractors to establish whether these will be subject to a reverse charge from October 2019;
- Consider the adaptions that will need to be made to their accounting systems to deal with this change and;
- Consider the impact on their cash flow from October 2019 of not receiving the VAT from their customer and if there are any other ways to mitigate this impact.
Please get in touch to speak to a member of either our Property, or VAT team if you would like to discuss how we may assist you in understanding the implications of the new rules for your business more generally.