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Laying the foundations for the Construction Industry VAT Reverse Charge

Undeserved it may be, but the construction industry suffers from a reputation for tax avoidance. It only takes a few cowboys who offer a discount for cash to tarnish all the others, which is why the sector has welcomed efforts to combat tax avoidance through the Construction Industry Scheme (CIS). Now, the government is looking to tackle VAT fraud within the sector, a problem that is estimated to cost the Exchequer over £100m a year.

To address the issue, HMRC is bringing in the VAT domestic reverse charge for building and construction services. This may seem like another complex and time-consuming piece of box-ticking for an industry that is already beleaguered by Brexit uncertainty, skills shortages and rising costs. But in truth, the VAT reverse charge is both simple to understand and – for those that put in the work – easy to implement.

Despite that, however, the reality is that many construction businesses are ill-prepared. For example, the Federation of Master Builders recently found that over two-thirds of SMEs in the sector hadn’t even heard of the charge – while of those that had, only 33 per cent were prepared for the changes.

As a result, HMRC recently announced that the compliance deadline will be pushed out to next year to give businesses more time to get their processes in order. The extension just underlines how important it is to prepare in advance for regulatory change, whether that means the regulator providing enough information or SMEs working out how to comply on time. A lack of preparation can cause costly delays and even result in fines.

The good news is that construction companies now have an extra 12 months to implement compliance programmes. To help them succeed, this guide to the VAT Reverse Charge provides everything you need to get your business ready.

What is the Construction Industry VAT Reverse Charge?

The goal of HMRC’s change is to fight against ‘missing trader’ fraud, where contractors receive high net amounts of VAT from their customers before going missing and pocketing money that’s owed to the taxman.

The problem stems from the fact that construction is a many-stepped process with multiple contractors involved along the way. Currently VAT is charged by the sub-contractor to various subcontractors and contractors in the chain of construction before finally being charged to the end-customer, providing plenty of scope for missing trader fraud.

When the reverse charge comes into effect this October, the liability to account to HMRC for the VAT will shift from the supplier of goods and services to the recipient with the exception of the end user. In other words, a contractor will no longer pay VAT over to their sub-contractor and will instead pay it directly to HMRC via their own VAT return.

Who is affected?

The Construction Industry VAT Reverse Charge applies to any businesses that are registered for VAT in the UK and supply or receive specified services that are reported under the Construction Industry Scheme (CIS). Under the CIS, deductions are made from payments to subcontractors by contractors and are passed onto HMRC as advance payments towards the subcontractor’s tax and national insurance.  Although contractors have to register for the scheme, subcontractors may or may not be officially registered so need to ensure they understand that if they provide specified supplies which are reported under the CIS then they will have to apply the reverse charge, whether they’re registered for the CIS or not.

There are exemptions, of course. The reverse charge should not be applied to supplies to end users and intermediary supplier businesses. End users are deemed to be consumers or final purchasers of building and construction services and may or may not be registered for VAT and CIS, Intermediary suppliers are VAT and CIS registered businesses that are connected or linked to end users.

In all, the Construction Industry VAT Reverse Charge is estimated to affect up to 150,000 businesses in the construction and business sector.

What is included?

The reverse charge will apply to supplies of building and construction services (with the exception of those that are zero rated which are excluded from the new legislation) that also need to be reported under CIS. These are referred to as specified supplies and a full list of what services are included and excluded are included in the HMRC guidance.

However, there is one significant difference between CIS and the reverse charge. Under CIS, payments to net-status sub-contractors are made on the service only but the reverse charge will apply to the whole supply including any materials. However, supplies of solely goods with no associated service are excluded from the reverse charge.

Although this distinction may seem like an added complication it’s intended to ease the burden of the impending legislation. In fact, to try and simplify the implementation, HMRC has specified that if any element of a supply is subject to the reverse charge then companies should simply apply the reverse charge to everything within the supply. This means invoices shouldn’t need to be apportioned and the reverse charge can either be applied to everything or nothing.

How does it work?

In practice, the supplier will need to check if the customer is registered for the Construction Industry Scheme (CIS) and is VAT registered.  If they are, then the supplier simply issues a slightly different VAT invoice that clearly indicates that the supplies are subject to the Construction Industry VAT Reverse Charge, and that it’s the customer who is required to account for the VAT.

While the VAT amount should be clearly stated, this must not be included in the total amount charged and the supplier will no longer include the VAT value in box 1 of their VAT return. The recipient must include this amount in their own VAT return in box 1 and effectively pay it over to HMRC rather than to the supplier.  If the supplier is invoicing a customer who is not VAT or CIS registered then there are no changes to the way invoices are raised or VAT is accounted for.

When does the Construction Industry VAT Reverse Charge apply?

Following the HMRC extension, the reverse charge requirement will begin on the 1st October 2020. This means that in most cases the reverse charge procedure should be applied to any invoice raised after this date even if it relates to work carried out before 1st October. For further explanation on when to apply the reverse charge please refer to the HMRC guidance.

Getting your business ready

With an extra year’s grace before the Reverse Charge comes into effect, construction businesses need to take concrete steps to ensure that they have the systems in place to ensure they can implement the reverse charge.

The latest versions of CIS-specific software from reputable vendors should take the Construction Industry VAT Reverse Charge into account and guide businesses through the required steps to ensure that they are compliant with the new rules. But not all software is equally capable or up-to-date, which is why it’s vital that construction businesses check their systems to ensure that they have the right tools in place before the deadline.

For example, you’ll need to check that your software can verify CIS statuses and that it gives you instant access to completely accurate data on subcontractors. Small to medium-sized businesses should also check that they have the ability to claim retentions held or owing without having to search manually through massive spreadsheets; they must also be able to easily chase up payments and keep on top of multiple applications across different projects.

Since variations are an inevitable part of any construction job, it’s also crucial that your CIS software can help you to send out an application for payment to your client to request additional costs, while ensuring that the Construction Industry VAT Reverse Charge is applied where required. The same goes for creating reports such as cost-value reconciliation and actual versus budgeted contract costing: the right software will save businesses significant amounts of time in hunting through paper records or spreadsheets.

The Construction Industry VAT Reverse Charge isn’t something to be feared; and similar schemes have worked well in other countries. Reviewing your software today won’t just mean that you’re compliant with the new rules when they come into effect; it will ensure that you’re prepared for other incoming changes.    

Sage – Adam Prince

By Adam Prince, Vice President of Product Management, Compliance, Brexit and Migration at Sage