VAT reverse charge for construction services March 2021

HMRC will introduce its delayed “Construction Industry reverse VAT charge” which will affect sub-contractors who supply their services to other contractors within the sector.

The measure was due to commence in October 2019 but has been delayed twice due to Brexit and Covid-19 with its aim being to reduce VAT fraud in the construction sector, estimated to cost the Treasury nearly £100m a year.

It is estimated that up to 150,000 businesses will be affected by the change. It will have significant impact on VAT compliance and cashflow.

The changes required to be put in place by businesses in order to comply with the new legislation could be significant and any affected business which has not yet taken steps to prepare needs to do so.

What is the VAT reverse charge?

The reverse charge is a way of accounting for VAT where the end-customer accounts for VAT and the supplier of construction services does not.

The reverse charge means the customer receiving construction services has to pay the VAT to HMRC instead of the supplier. The end-customer recovers VAT subject to the normal rules set by HMRC.

VAT Change for Construction Businesses

Supplies of standard or reduced -rated construction services between UK VAT and CIS registered businesses in the supply chain will not be invoiced in the normal ways. Under the new reverse charge system, the sub-contractor will not charge VAT on their invoice to the contractor for whom they are working.

They will not account for output VAT either, although they will identify the rate and amount of VAT due and notify their customer that the VAT must be accounted by them on their VAT return.

The sub – contractor will then be paid only the net value of the work done without the VAT.

The contractor receiving supplies from the subcontractor will be obliged to enter the VAT identified on their sub-contractors’ invoice in box one of their VAT return as well as claiming this back in box four of their return.

When was the VAT reverse charge for construction services introduced?

The VAT reverse charge for construction came into force on 1 March 2021. It was initially planned to start from October 2019 but was postponed to October 2020 to “avoid the changes coinciding with Brexit” and “to help businesses and give them more time to prepare” according to HMRC.

However, due to the impact of the coronavirus outbreak on the construction industry, HMRC extended the October 2020 date by a further five months.

Who is Affected by the VAT Reverse Charge?

The reverse charge is to be applied when all the following are met:

• The supply for VAT consists of construction services and materials
• The services provided are standard rated or reduced rated
• Supplier and customer are both UK VAT and CIS registered
• The customer will be making an ongoing supply of construction services to another party

CIS reverse charge does not apply for the following :

• Supplies of VAT exempt or zero-rated services
• Supplies not covered by the CIS
• “End-Users” [1] i.e., a VAT registered customer who is not intending to make further on going supplies of construction.
• “Intermediary Suppliers” [2] who are connected e.g., two companies in the same group.
• Supply of staff or workers [3]

The reverse charge must be used for the following services:

• Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not). This includes offshore installation services
• Constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land. This includes, (in particular), walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours, pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence
• Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure
• 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 inside or the external surfaces of any building or structure
• Services which form an integral part of or are part of the preparation or completion of the services described above. This includes site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works

What’s exempt from the VAT reverse charge for construction services?

• Drilling for, or extracting oil or natural gas
• Extracting minerals (using underground or surface working) and tunnelling, boring or construction of underground works for this purpose
• Manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site
• Manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to site
• The professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants
• Making, installing, and repairing art works such as sculptures, murals and other items that are purely artistic 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

 Certain services can become included:

• If there is a reverse charge element in the supply, then the whole supply will be subject to the domestic reverse charge
• If there has already been a reverse charge service between two parties on a construction site, and if both parties agree, any subsequent construction supplies on that site between the same parties can be treated as reverse charge service
• If there is doubt whether a type of work falls within the definition of a specified service, as long as the recipient is VAT registered and the payments are subject to CIS, the reverse charge should apply
• The contractor is asked to consider all construction contracts with a sub-contractor. If they can see that reverse charge applies to more than 5% of contracts (by volume or value) with that subcontractor, then the reverse charge may be applied to all the contracts.

Key Definitions  

1. End Users

The reverse charge is not intended to apply where a contractor works directly for an end user.

End users are consumers and businesses, or groups of businesses, that are VAT and Construction Industry Scheme registered but do not make onward supplies of the building and construction services supplied to them. Namely those who have an interest in the land where the work is being undertaken.

Where the end user is VAT and CIS registered, the reverse charge does not apply to supplies made to them where they notify the contractor in writing that they are an end user.

2. Intermediary Suppliers

Intermediary suppliers are VAT and CIS registered businesses that are in a corporate group with an end user as defined above. If an intermediary supplier buys construction services and re-supplies them to an end user in the same corporate group, they are all treated as if they are an end user and the reverse charge does not apply. They do however need to notify the contractor that they are an end user.

3. Supply of Staff or Workers

Employment businesses are treated differently for the purpose of the reverse charge. Supplies by employment businesses (also known as labour agencies) are not subject to the reverse charge, even if those supplies are within the scope of CIS.

Employment agencies supplying construction workers are, for VAT purposes, treated as supplying staff rather than building and construction services.

How to Prepare?

Guidance on whether the reverse charge applies to you

Using the reverse charge: Suppliers/ Sub Contractors

Suppliers must use the reverse charge from 1 March 2021. This applies if you’re VAT registered in the UK and you supply building and construction industry services and:

• Your customer is registered for VAT in the UK
• Payment for the supply is reported within the Construction Industry Scheme (CIS)
• The services you supply are standard or reduced rated
• You’re not an employment business supplying either staff or workers, or both
• Your customer has not given written confirmation that they are an end user or intermediary supplier

The following practical steps well help you to stay compliant:

• Check if your customer has a valid VAT number
• Check your customer’s CIS registration
• Review your contracts to decide if the reverse charge will apply and tell your customers
• Ask your customer to confirm whether they are an end user or intermediary supplie
• Make arrangements to alter your invoicing to identify the rate and amount of VAT due but not to charge it to your customer. Also ensure that a narrative appears on the invoice instructing the customer to declare the VAT on their VAT return
• Find out how to record the reverse chargeable transactions in your accounts
• Analyse the impact of the new rules on your cash flow and consider applying for monthly VAT returns

Using the reverse charge if you are a customers

You must account for the reverse charge from 1 March 2021, if you are VAT registered in the UK, receive supplies of building and construction industry services and:

• Your supplier is registered for VAT in the UK
• Payment for the supply is reported within the Construction Industry Scheme (CIS)
• The services you receive are standard or reduced rated
• Your supplier is not an employment business supplying either staff or workers, or both
• You’re not an end user or intermediary supplier who has notified your suppliers of that fact

The practical steps you will need to take include:

• Check if your supplier has a valid VAT number
• Check your supplier’s CIS registration
• Review your contracts to decide if the reverse charge will apply and tell your suppliers you will not accept normal VAT invoices
•  Make arrangements to account on your VAT returns for the VAT identified as due to HMRC on your suppliers’ invoices
• Ensure that you refuse any normal VAT invoice issued to you by a sub-contractor where the reverse charge should be applied
• Make arrangements to pay only the net value of the work to your sub-contractor
• Find out how to account for the reverse charge transactions in your accounts

What if my business is both a supplier and a customer?

Many businesses in the construction sector are both suppliers and customers and will be affected in relation to purchases and sales. The above practical steps will need to be taken in respect of both.

Upgrade accounting systems and software

Accounting systems and software need to be able to deal with the reverse charge. Ensure that those responsible for VAT accounting are familiar with the changes and are confident in what processes need to be in place post March 1st.

Read more: What to do if you cannot pay your CIS tax?

The domestic reverse charge will have a significant impact on VAT compliance and cash flow management for the businesses involved. New systems and processes will need to be introduced or current systems and processes will need to be amended in order for businesses to be able to implement the new rules as of 1 March 2021.

Smaller sub-contractors may currently rely on the positive cashflow in respect of the VAT element of contract payments which will disappear in relation to reverse charge supplies. There are concerns that the reverse charge could cause significant cashflow difficulties for smaller sub-contractors. In order to minimise disruption to their supply chain, contractors may want to ensure that their sub-contractors have prepared for the reverse charge.

Customers who are end users will need to consider whether they want to notify the supplier that the exemption will apply, or whether they would prefer to operate the reverse charge. If they choose to operate the reverse charge, system changes may be necessary.

Penalties are imposed for errors in VAT returns. In its guidance HMRC says that it will “apply a light touch in dealing with related errors that occur in the first six months of the new legislation, as long as you are trying to comply with the new legislation and have acted in good faith”.

The implementation of the reverse charge was delayed until 1 March 2021 due to the impact of the coronavirus crisis on the construction sector. 

Cashflow Implications

Under existing arrangements, a supplier or subcontractor charges VAT to their customer and has the option to use these funds as short-term working capital before settling the outstanding VAT liability within their quarterly VAT return. Now many businesses will have to cover the costs of purchasing construction supplies from their own resources and they should consider and plan for the impact of this on their day-to-day cashflow.

Similarly, customers paying for construction supplies and services will need to check that the Vat being charged is correct and to ensure that VAT is paid when it becomes due. Overpaid VAT will not be reimbursed, and undercharging will be met with penalties which will impact upon their cashflow.

Should your business be affected by the reverse charge then speak to our team regarding any cashflow concerns that you may have.