To tackle VAT fraud in the construction industry a domestic reverse charge will be introduced with effect from 1 March 2021. Alison Birch, VAT partner at Mitchell Charlesworth, explains what this means for businesses in the construction industry.
1. What is a reverse charge?
The reverse charge is a mechanism for accounting for VAT whereby the customer charges themselves VAT, rather than the supplier charging VAT. The domestic reverse charge is commonly used to prevent missing trader fraud i.e. the supplier will charge VAT, be paid the VAT and then ‘go missing’ before they declare it to HMRC. As the reverse charge makes it the customer’s responsibility to account for VAT there is no opportunity for the supplier to disappear without paying the VAT to HMRC.
2. What does this mean for me?
It means you may no longer need to charge VAT to your customers or no longer be charged VAT by your suppliers. You will need to review your contracts with customers and suppliers to see whether they are impacted by the reverse charge.
3. How does it work in practice?
If you are supplying a service that meets all the criteria for the reverse charge, you no longer charge VAT to your customers. You will need to validate that they are VAT and CIS registered and not an end user. If you use software to account for VAT and generate invoices you may need to change your tax codes. The sale should be reported in Box 6. Invoices should include wording that makes it clear that the domestic reverse charge applies and that the customer is required to account for the VAT. The invoice should also state how much VAT is due under the reverse charge, or the rate of VAT. The amount of VAT should not be included in the amount charged to the customer.
If you are receiving a service that meets all the criteria for the reverse charge and you are VAT and CIS registered and not an end user, you won’t be charged VAT by your supplier. You will need to charge yourself VAT, so the VAT due will be paid to HMRC in Box 1 and reclaimed in Box 4 (subject to the normal rules). The net value should be reported in Box 7. If you use software, you may have a tax code for the receipt of reverse charge services which will automatically calculate the VAT.
4. What construction transactions does the domestic reverse charge cover?
This domestic reverse charge will only apply to supplies of building and construction services that are subject to VAT at the standard or reduced rates that also need to be reported under CIS. These are called specified supplies. HMRC have prepared a flowchart which has been replicated here (click on the image to enlarge).
5. What are specified construction services?
Specified construction services include:
- constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services
- constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, 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, 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 – 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.
The reverse charge will also apply to materials supplied with those construction services. If a supply contains a mixture of specified and other construction services, it will be classed as a single supply of specified services and the domestic reverse charge will apply.
6. What supplies are excluded?
The following are not included within the definition of 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.
Additionally, supplies of specified construction services that are not used to make an onward supply of construction services will not be subject to the reverse charge. This means that the new rules only apply to businesses that are supplying their construction services to another business who will sell on these construction services. It does not apply where the construction services are provided to an ‘end user’ of those services (i.e. supplied to a business that has commissioned the construction of a new building). There will also be an exclusion for connected businesses. In these situations, normal VAT rules will apply. You will need to ask your customer to confirm if they are end user if you are not sure.
7. When will the domestic reverse charge on specified construction services be introduced?
The domestic reverse charge will be introduced on 1 March 2021.
8. How should building contractors prepare for this change?
Businesses that supply or receive construction services need to understand how they may be impacted by this change. They should be identifying instances where they supply services to other businesses in the construction sector (rather than to a consumer of those services) or receive them for the purposes of selling them on. If they do operate in this way, they need to determine whether the services are included within the list of specified services. Suppliers that are caught by this will no longer charge VAT on their services as the recipient will charge themselves VAT. This could mean that businesses find themselves in a VAT repayment situation and want to move from quarterly to monthly VAT returns.
For more information please contact Alison Birch below.