VAT Domestic Reverse Charge in the Construction Industry
The collection and charging of VAT in the construction industry will change dramatically under draft legislation due to come into effect on 1 October 2019.
Under the new arrangements, designed to combat unscrupulous contractors and their handling of VAT, a supplier or subcontractor will not charge VAT on those services falling within the definition of “construction operations”. The main contractor will, instead, effectively charge the VAT to itself and recover it as Input Tax, under a process known as the VAT Domestic Reverse Charge.
In simple terms this new Domestic Reverse Charge (DRC) will only apply to those services that are currently subject to VAT at the standard or reduced rate and are already reported under the Construction Industry Scheme rules.
However, unlike the Construction Industry Scheme (CIS), the VAT charge is levied on the whole contract value, not just the labour element.
The affected supplies will include a wide range of services, including the construction, alteration, repair, demolition, painting and decorating, cleaning and finishing of all types of property.
If there is any reverse charge element within a supply, then the whole supply will be subject to the charge.
“Determining whether supplies are part of a wider, single supply or are discrete in themselves is complex,” explains Alan Rolfe, Senior Tax Manager. “There have already been a host of disputes across many industries”.
Certain supplies remain unaffected by the DRC and for these items VAT will still be charged by the subcontractor as usual. This includes supplies to an “end user”, local education authority or charity, and most supplies to a business in connection with its own business premises.
If there has already been a domestic reverse charge supply on a construction site, and if both parties agree, the charge will apply to all subsequent supplies on that site between the two parties.
“In its simplest form, the new Domestic Reverse Charge will apply to the listed construction services, but in practice, contractors might find it simpler to insist that subcontractors reverse charge all services. The main contractors will not incur a VAT burden as the amount incurred under the reverse charge will be fully recoverable, as their onward supplies will be taxable under the zero, reduced or standard rate.”
“There will be some suppliers who cannot agree to apply the reverse charge, such as suppliers of goods only (materials, parts) without installation services, but this would minimise piecemeal charges of VAT and reverse charged services.”
There are three main drawbacks to the new system. Firstly, the contractor and subcontractor need to determine and agree the appropriate VAT treatment for each supply. Secondly, the subcontractor will likely suffer a significant cashflow disadvantage from receiving only net of VAT payments under the DRC and, finally, there may be a significant administrative overhead in implementing the new procedures.
The Guidance Note published at the same time as the draft legislation brings its own concerns. HMRC policy states that it will be the end user’s responsibility to declare that they are an “end user” in writing and if they don’t, they will still be responsible for accounting for the reverse charge. Practically, this may cause real issues – not least because consumers or VAT registered businesses are unlikely to know about their obligations under the charge.
Invoices issued are required by law to include a reference to “reverse charge”, but there is no prescribed wording. Suggested possible wording could be: “Reverse charge: VAT Act 1994 Section 55A applies” or “Reverse charge: Customer to pay the VAT to HMRC”.
“The new Domestic Reverse Charge is an important development in the fight against suppliers who fail to pay to HMRC the VAT which has been collected. While it is not expected to change the overall VAT burden for those involved, the reverse charge is a counter-intuitive mechanism and some issues will arise in an industry as large and varied as construction,” says Alan.
For further information on the Domestic Reverse Charge, please contact Alan Rolfe on 023 8046 1235.