The construction industry domestic reverse charge scheme The VAT domestic reverse charge for building and construction services is scheduled to come into effect on 1 March 2021.

These major VAT changes will affect all VAT registered builders who work for the construction industry clients. It is therefore crucial that accounting procedures are updated, and that staff are made clear about when the reverse charge will and will not apply to avoid any potential issues with HMRC.

The charge will only affect supplies at standard or reduced rates where payments are required to be reported via the Construction Industry Scheme (CIS). 

It does not apply: 

• To zero-rated supplies i.e. VAT liability on construction services for new build dwellings etc 
• To services supplied to ‘end users’ or ‘intermediary suppliers’ who have given written confirmation of their status to their supplier in respect of the services supplied 

• To a business that only supplies either staff or workers i.e. employment agency.

How the scheme works: 

The reverse charge will only apply if the supplier (subcontractor) and customer (main contractor) are both trading in the construction industry (CIS scheme users) and are VAT registered.

A typical situation would be a subcontractor working for the main building contractor on a specific project. The customer must be registered for the Construction Industry Scheme (CIS) and the work in question must come within the scope of the CIS, e.g. decorating a house or laying bricks etc. The work must also be subject to either 5% or 20% VAT. 

However, the key condition is that the business receiving the supplies from the subcontractor must be making an onward supply of these services to another customer i.e. ‘end user’.

An end user means that the services supplied by the subcontractor is not relevant to an onward supply of construction services made by the main contractor. For example, it might relate to building work carried out at a head office, or if a property is rented out to a tenant – in this situation the reverse charge will not apply, and the onus is on the main contractor to advise the subcontractor that it is a ‘end user’ for that particular job. The subcontractor would then charge 20% or 5% on his invoice as previous.

What about an intermediary supplier?

A business that is registered for both CIS and VAT and is connected or linked to end users i.e. because they are part of the same corporate group will not be subject to the new reverse charge provisions. A link will exist where an intermediary supplier and end user have a relevant interest in the same land where the building work takes place, such as a landlord and tenant situation. In this instance, even though the intermediary supplier is making an onward supply of construction services to the end user, any supplies received from subcontractors will be subject to the normal VAT rules and should be invoices as normal i.e. subcontractor applies VAT on his invoice raised to the intermediary. 

End user and intermediary supplier responsibilities 

A customer who receives building/construction services must always notify a supplier in writing to confirm of an end user or intermediary supplier situation. As per HMRC’s suggested guidance a supplier can include a statement in the terms and conditions of a contract saying something along the lines of: ‘we will assume you are an end user or intermediary supplier unless you confirm you’re not.’ By adopting such an approach, a supplier of construction services can protect themselves against future penalty assessment by HMRC. It is important that customers take care in understanding such rules because where they are charged VAT on ’reverse charge’ supplies, HMRC will have powers to assess for output tax again i.e. a double VAT charge on the services. The customer will then be in a situation where to balance the books a VAT credit is sought from the original supplier who charged the VAT on the invoice.

Scheme calculations

A VAT registered plumber working as a subcontractor to a main contractor who itself will be providing onwards construction services to a firm of accountants for the construction of a new office would invoice as following from 1st March 2021: 

1. Plumber invoices post 1st March 2021 for example £10,000 and applies no VAT under the new scheme. The plumbing firm would include the £10,000 sale in Box 6 of their UK VAT return i.e. outputs box. 

2. The main contractor will then account for £2,000 output tax in box 1 of their own UK VAT return as the work supplied was subject to 20% VAT. Main contractor would then reclaim the same £2,000 amount as input tax within Box 4 subject to the normal VAT rules i.e. where a business has no input tax restriction on the supply due to partial exemption or non-business issues. The £10,000 net value purchase would be included in Box 7 inputs box on the VAT return.

Can I invoice split? 

As there will no longer be any physical payments made between two parties where the reverse charge applies some subcontractors will be badly affected by this cash flow outcome of no longer collecting VAT from customers and keeping it within their bank accounts for up to 3 months before physical payment is due to HMRC via the VAT return submission. 

It has been suggested by some firms adversely affected by the above cash flow outcome on whether they were able to raise separate sales invoices for each job. For example, raise an invoice for building materials which is not subject to the reverse charge) and a separate invoice for labour (which is subject to the reverse charge). 

Unfortunately, as per the VAT legislation such an arrangement possibility would be challenged as the subcontractor’s jobs would be viewed as a single supply of construction services with materials, and by issuing to separate invoices the VAT position would not change.

HMRC have issued further guidance on such arrangements and we can confirm that invoice splitting is not plausible despite the obvious cash flow disadvantages now applicable.

The 5% disregard

As part of the newly introduced scheme a new concept will be added which relates to the situation where only some of the work on an invoice is subject to the reverse charge, but this amount is 5% or less than the total value of the invoice. The previous approach was that all of the invoice would be subject to the reverse charge, even if only £1 was relevant to the reverse charge work.

For example, a decorator has a contract with a construction industry client for two jobs. The first is to redecorate multiple rooms in the company’s head office for a payment of £9,000. The client has confirmed to the decorator that it is an end user for this work. The second job is to decorate a room in a hotel, which relates to a contract being done by the decorator’s client for a hotel chain for a payment of £350. The decorator will issue a single invoice for both jobs. The whole invoice would normally be subject to the reverse charge because it includes some reverse charge work; i.e. decorating the hotel. However, because the reverse charge work represents ‘5% or less’ of the total invoice (£350 divided by £9,350 = 3.7%), normal VAT rules apply i.e. decorator charges £9,350 plus £1,870 VAT on the whole invoice.

 Key points 

1. If a subcontractor does not charge VAT on a sales invoice due to mistakenly thinking that the ‘reverse charge’ applied, or if a construction industry main contractor buying in construction services incorrectly pays VAT to a supplier when the ‘reverse charge’ should have been applied, HMRC will have powers to raise assessments to correct the errors made.

2. The reverse charge will also apply to any materials supplied by the subcontractor as part of his work. 

3. To account for the relevant VAT, the customer receiving the reverse charge invoice must use either the invoice date or payment date, whichever happens first. 

4. Where a subcontractor is using the flat rate scheme, reverse charge sales are completely excluded from the usual VAT return filings and must be accounted for separately. It will therefore be prudent for such a user of the scheme to leave the scheme if the reverse charge applies and is of significant value so that input tax can be reclaimed on expenses. 

5. The ‘5% disregard’ legislation must be fully understood to avoid any potential issues with HMRC.