By Nikki Spoor, Travel, Audit and Tax Director at White Hart Associates
A new VAT rule to combat fraud in the UK construction industry is eventually being introduced on March 1st and the estimated 150,000 small and medium sized businesses in the sector must prepare for major changes.
The Construction Industry Scheme (CIS) domestic reverse charge scheme was due to become law in October but has been delayed because of Brexit and the pandemic.
For nearly 50 years, UK suppliers have accounted for their own VAT and many businesses have been able to use the payments from customers as working capital before sending the funds to Her Majesty’s Revenue and Customs (HMRC).
But the government wants to stamp out fraud costing millions of pounds per year when suppliers or contractors charge VAT but then go into liquidation of otherwise disappear without passing money on to HMRC.
The new scheme will stop the transfer of VAT between VAT-registered businesses in the construction industry and businesses will effectively lose 20% (the current VAT rate) of their cash flow.
Rather than the supplier of goods charging and accounting for the VAT, the recipient of those supplies will account for the VAT.
Main contractors will, then, effectively charge themselves VAT on subcontractors’ goods and services. Instead of paying the appropriate VAT to the subcontractor, they will pay it direct to HMRC on their VAT returns. The new rules continue throughout the supply chain until contractors sell to clients who do not then sell on services.
Businesses will need to check that their systems can cope with any change. Most software accounting systems have reverse charge VAT codes and can administer VAT filing, but errors could lead to HMRC disallowing VAT inputs claimed on supplies that have been made under the new reverse charge rules.
Key conditions of the scheme
The reverse charge must be applied when the following conditions are met:
- The supply for VAT consists of construction services and materials.
- It is made at a standard or reduced rate of VAT.
- It is between a UK VAT-registered supplier and UK VAT-registered customer.
- Both supplier and customer are registered for CIS.
- The customer intends to make an ongoing supply of construction services to another party.
- The supplier and customer are not connected.
The CIS reverse charge does not apply to any of the following supplies:
- Supplies of VAT-exempt building and construction services.
- Supplies that are not covered by the CIS, unless linked to such a supply.
- Supplies of staff or workers.
The CIS reverse charge does not apply to taxable supplies made to the following customers:
- A non-VAT registered customer.
- End users such as a VAT-registered customer who is not intending to make further on-going supplies of construction.
- Intermediary suppliers who are connected, for example a landlord and his tenant or two companies in the same group.
CIS businesses will need to be aware of the following:
- Staff will need to be trained to identify relevant CIS contracts and end users.
- Accounting and book- keeping systems will need to be modified to cope with the new invoicing and reporting obligations.
- The use of the VAT Flat Rate Scheme and cash accounting may not be possible.
- Cash flow will be affected and those at the start of the supply chain may become VAT repayment claimants: they need to consider whether to file monthly returns.
- A business that is the recipient of the supply may be required to register for VAT.
- Where both the supplier and the recipient are VAT registered or should be VAT registered, the recipient is liable to account for and pay the VAT to HMRC on behalf of the supplier. The supplier will not make a VAT payment on those supplies.
When supplying a service subject to the CIS reverse charge, suppliers must show all the information that is normally required on a VAT invoice, except that:
- A note on the invoice must make clear that the CIS reverse charge applies and that the customer is required to account for the VAT.
- No VAT is charged on the invoice.
- It should state how much VAT is due under the reverse charge, or the rate of VAT if the VAT amount cannot be shown, but that VAT should not be included in the amount charged to the customer.
- Under the VAT Regulation 1995, invoices for services subject to the reverse charge where the customer is liable for the VAT must include the reference ‘reverse charge’. Here are some examples of wording that meets the legal requirement:
- Reverse charge: VAT Act 1994 Section 55A applies.
- Reverse charge: S.55A VATA 94 applies.
- Reverse charge: Customer to pay the VAT to HMRC.
Enclosed is an example of a reverse charge invoice for one contract with different VAT Rates: CIS Example Invoice
Example: How the CIS reverse charge works
Peter the Roofer, who is VAT registered, supplies the materials and roofs a new office building for Steve the Contractor, who is also VAT registered. Steve the Contractor in turn supplies construction services to Jane the Developer, who is also VAT registered. Jane the Developer finds and develops land and will, in this case, bring the build to completion and supply a finished commercial building to the end user, her client.
Under the old VAT system:
John the Roofer invoices Steve the Contractor £100,000 for materials, labour and works, plus £20,000 VAT, making a total invoice of £120,000.
Under the new scheme, from March 2021:
John the Roofer invoices Steve the Contractor for £100,000. His invoice states that ‘the CIS reverse charge applies’ and that the applicable rate of VAT is 20%. Steve the Contractor pays John the Roofer £100,000. Steve the Contractor then accounts for output and input VAT of £20,000 on the supply on his own VAT return.
John the Roofer does not account for output VAT in his accounting system as he has invoiced only his fee of £100,000. As a consequence of the reverse charge procedure, John the Roofer charges and receives £20,000 less than under the old system. He does not have to account to HMRC for any output tax on the transaction. When he is paid by Steve the Contractor, he includes the value of the sale in box 6 of his VAT Return. He does not add VAT to box 1 as he receives no output VAT.
The change may well impact John the Roofer’s cash flow as, under the old rules, if Steve the Contractor was a prompt payer he could hope that he could use the £20,000 in VAT to purchase materials. He could then purchase his materials and offset the input tax paid against his output liability.
Steve the Contractor has a cash flow advantage, as he does not have to pay John the Roofer £20,000 and then at the end of his VAT quarter cannot reclaim £20,000 as he is accounting for the reverse charge and the output VAT offsets the input VAT.
As Steve the Contractor is supplying CIS services he must also consider the reverse charge. Will his client, Jane the Developer, be involved in the onward supply of CIS services? In this case, this may be difficult to determine as apparently Jane the Developer is selling a finished building to the end user as an investor and the reverse charge does not apply. It is Jane the Developer’s responsibility to notify down the supply chain.
What services are within the CIS reverse charge?
- 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. This includes 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.
- 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 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.
Certain services that can become included:
- If there is a reverse charge element in a supply, then the whole supply will be subject to the domestic reverse charge.
- 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.
- If there is doubt whether a type of works falls within the definition of a specified service, as long as the recipient is VAT registered and the payments are subject to CIS, the reverse charge should apply.
- The contractor is asked to consider all construction contracts with a sub-contractor. If they can see that reverse charge applies to more than 5% of contracts (by volume or value) with that sub-contractor, then the reverse charge may be applied to all the contracts.
Example: A joiner constructing a staircase offsite and then installing it onsite is making a reverse charge service, even if the charge for installation is only a minor element of the overall charge.
Treatment of existing contracts to be ready for March 1st, 2021
The VAT treatment is determined for payments due on any supplies entered into your accounting system before March 1st, 2021 but paid on or after March 1st, 2021.
For contracts starting after March 1st, 2021, you should decide whether the reverse charge applies from the start of the contract.
|Date entered in customer’s accounting system||Date payment made||VAT Treatment|
|Before March 1st, 2021||On or before May 31st, 2021||Normal VAT rules|
|Before March 1st, 2021||On or after June 1st, 2021||Domestic reverse charge|
|On or after March 1st, 2021||On or after March 1st, 2021||Domestic reverse charge|
For more information:
White Hart Associates are specialist accountants for the travel industry. Visit whitehartassociates.com or contact 0208 878 8383 for more information.