Domestic VAT Reverse Charge- Building and Construction sector changes

What is the VAT Reverse Charge for the Construction Industry, and how does it apply? 

Domestic VAT Reverse Charge (aka CIS Reverse Charge) is a piece of legislation that shifts the way the Construction Industry Scheme (CIS) & Value Added Tax (VAT) registered Contractors and Sub-Contractors handle and settle Value Added Tax.  

Under normal circumstances, a supplier that is registered for VAT simply charges the relevant amount on top of their normal taxable supplies. The responsibility for collecting and paying the VAT over to HMRC remains with the supplier. 

From 2021 onwards the new rules for those operating within the construction industry, involve the transfer of the responsibility to charge VAT from certain types of suppliers (sub-contractors) to the customer (contractor). In this case, the customer receiving a service will no longer pay the VAT portion of an invoice to the supplier, instead of paying the VAT directly to HMRC. 

The new legislation came into effect on 1st March as an anti-fraud measure to eradicate criminal attacks on the UK VAT system. The rules aspire to eliminate “missing trader” fraud, where suppliers receive VAT from their customers but fail to pay the VAT to HMRC. 

Who is affected by the Reverse Charge? 

The Reverse Charge applies to VAT-registered businesses that supply or receive standard or reduced-rate VAT construction services reported under CIS in the UK. It does not apply to zero-rated services. 

If your business receives an invoice with the Reverse Charge applied, you must account for the VAT amount as part of your overall input tax.  

For clarity, we have created a HMRC- sourced pdf flowchart to illustrate when the Reverse Charge is applied. 

Are you a business receiving building and construction, click here!

Deciding whether to apply normal VAT rules or reverse charge rules, click here

The Reverse Charge does not apply to taxable supplies made to the following customers: 

• A Non-VAT registered customer.
• ‘End Users’ 
• ‘Intermediary suppliers’

End users and intermediaries 

End-users are VAT and Construction Industry Scheme registered businesses that do not supply building and construction services supplied to them. An ‘intermediary supplier’ receives domestic reverse charge services and makes an onward supply of those services (or part) without material alteration or further processing. They could also be connected to the end-user by either the usual connected parties’ rules or by having an interest in the same land or property as the end-user (for example, landlord and tenant). 

They should send a reverse charge letter to each of their sub-contractors advising them that VAT Reverse Charge does not apply to the invoices sent to them. Sub-contractors that receive a similar letter from their contractors should clear the VAT Reverse Charge check box from their contractor’s contact record. 

Which services are affected by the Reverse Charge? 

The Reverse Charge only applies to businesses that supply services to another business, that will also still sell on that service. It does not apply to those that provide services to consumers. You ought to use the Reverse Charge for the following services: 

• Construction, alteration, repair, extension, demolition, or dismantling permanent or non-permanent buildings or structures. It also includes offshore installation services. 
• Construction, alteration, repair, extension, or demolition of any works forming (or planned) part of the land, including (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 as carried out during their construction, alteration, repair, extension, or restoration. 

• Painting or decorating the inside or the external surfaces of any building or structure. 
• Services that form an integral part of or are part of the preparation or completion of the services described above – including 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 vat reverse charge construction delay. 

 VAT reverse charge exemptions

VAT reverse charge cannot be used on these services when supplied on their own: 

• Drilling or extracting oil or natural gas. 
• Extracting minerals (using underground or surface working) and tunnelling, boring, or construction of underground works. 
• 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 of any of these to site. 
• Professional work of architects or surveyors, or of building, engineering, interior or exterior decoration, and landscape consultants. 
• Making, installing, and repairing artworks 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. 

What you must do, before starting reverse charge 

To prepare for a Reverse Charge, you need to: 

• Ensure your accounting systems and software can deal with the Reverse Charge. 
• Evaluate the impact that the change will have on your cash flow. 
• Educate your VAT accounting staff on how the VAT domestic reverse charge works. 
• If upon review you realise the VAT Reverse Charge does not apply to you, follow the normal VAT rules.  

How the Reverse Charge works/ technical guide 

As explained previously without the Reverse Charge suppliers would charge VAT and include it in the invoice to the customer. They would then report and pay the output VAT charged to HMRC via the VAT return. 

When handling Reverse Charge, a VAT registered supplier should no longer add VAT to their invoice, but instead, they should notify the customer that the supply/invoice is subject to Reverse Charge. The customer should then account for the output VAT. The customer must account for the output tax (in box 1 of the VAT return) and claim the input tax (in box 4 of the VAT return). 

The 5% rule 

Given that all invoiced services are subject to the Reverse Charge, it is applied to the whole invoice, including materials. Nonetheless, if the reverse charge part is 5% or less of the value of the whole invoice, it can be disregarded, and normal VAT rules will apply. 

Points to note 

• The entire supply will be liable to the domestic Reverse Charge if there is a reverse charge component in a supply.  
• 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 services. 
• In case there is uncertainty if a type of work falls within the definition of a specified service, the Reverse Charge should apply if the recipient is VAT registered and the payments are subject to CIS.  
• If upon consideration, a contractor and subcontractor realise their construction contracts apply to more than 5% of their contracts together (by volume or value), then the reverse charge may be applied to all the contracts. 

 Guidelines for subcontractors 

A supplier is qualified to work within Reverse Charge if: 

• Are VAT registered in the UK. 
• Supply building and construction industry services. 
• Your customer is registered for VAT in the UK. 
• Payment for the supply is reported within the Construction Industry Scheme (CIS). 
• Services supplied are standard or reduced rated. 
• Are 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. 

What a subcontractor must do 

1. Check if your customer has a valid VAT number. 
2. Check your customer’s CIS registration. You can check if your customer is registered on Construction Industry Scheme registration online. Customers who are also contractors for CIS purposes may not show up on such checks. Contact Spondoo Accountants for support in such a scenario. 
3. Review your contracts to decide if the Reverse Charge will apply and tell your customers. 
4. Ask your customer to confirm whether they are an end-user or intermediary supplier. 
5. Confirm if your accounting systems and software can account for the Reverse Charge. If they do (you will have to upgrade to a cloud software if they do not), make sure the invoice you receive is correct and check the list of services that must use the Reverse Charge. 

A subcontractor should not enter anything in box 1 of the VAT return. However, they must record the net sale in box 6. If you are using an accounting system, you should use the correct tax code for the transaction to fall into the correct boxes. Consequently, make sure your invoices show that the Reverse Charge applies so that customers will no longer pay you any VAT. When reconciling customer’s payments against invoices issued, remember to withhold the VAT element for any CIS-related supplies with any VAT registered customers.  

As the subcontractor is not paying VAT on their sales, they may become a repayment trader with HMRC. That means your business VAT return claims money from HMRC rather than making a payment. HMRC advises such businesses to make monthly returns to speed up payments received from HMRC. 

Guidelines for contractors 

A contractor is liable to Reverse Charge if: 

• Are VAT registered in the UK. 
• Buy building and construction industry services. 
• Payment for the supply is reported within the Construction Industry Scheme (CIS) 
• The supply is standard or reduced rated. 
• Are not hiring either staff or workers, or both. 
• Are not using the end-user or intermediary exclusions. 

What a contractor must do 

1. Check if your supplier has a valid VAT number. 
2. Inform your supplier if you are an end-user or intermediary supplier. 
3. Find out how to account for the charge. 
4. Find out how to record the Reverse Charge in your accounts. 

A contractor should account for the Reverse Charge VAT the subcontractor has notified you of. For your VAT return, enter the output tax on purchases to which the domestic Reverse Charge applies in box 1. You should not enter the value of such purchases in Box 6. It is worth bearing in mind that you can reclaim the input tax on your domestic reverse charge purchases in Box 4 of the VAT return and include the value of the purchases in Box 7. You will be required to pay any VAT due directly to HMRC as part of your normal VAT settlement process. The overall effect on your VAT liability will be neutral because the output VAT is covered by the input VAT. To pay the right amount of VAT, ensure the invoice you receive has correct VAT rates and the services listed are eligible for the Reverse Charge.  

What to do if you are both a contractor and subcontractor 

If you are a subcontractor on one project and the main contractor on another, observe the VAT status of your services for each construction project you are working on. 

Feel free to contact Spondoo Accountants on how to go about this. 

VAT reverse charge Invoices (with example) 

An invoice subject to the domestic Reverse Charge must: 

• Indicate all the information required on a VAT invoice. 
• Have a clear note on the invoice indicating that the domestic Reverse Charge applies, and that the customer should account for the VAT. 
• Demonstrate how much VAT is due under the reverse charge. The VAT rate should be indicated if the VAT amount cannot be shown. 
• Must have the reference ‘reverse charge’. HMRC wording that meets the legal requirement are- reverse charge VAT Act 1994 Section 55A applies, Reverse Charge: S55A VATA 94 applies or Reverse Charge: Customer to pay the VAT to HMRC. 

If your software cannot show the amount of VAT to account for under Reverse Charge, contact Spondoo Accountants for guidance. 

What if I fail to comply with the Reverse Charge? 

Being new legislation, HMRC is aware of the difficulty in the implementation of Reverse Charge. In this regard, they will apply a light touch in dealing with any errors made in the first 6 months of the new legislation. HMRC officers may assess for mistakes during the light touch period. However, you will be liable to penalties if HMRC feels you are intentionally taking advantage of the measure by not accounting for it correctly.  

Reverse Charge errors should be corrected quickly because lengthy outstanding under–declared or overcharged sums are hard to correct or recover. It is advisable to consult an accountant if the new reverse charge VAT rules apply to your business. 

Do you have more questions on Domestic Reverse Charge? Contact us for Reverse Charge compliance support.