A new VAT rule introduced to combat fraud will hit the cash flow of up to 150,000 small and medium sized businesses in the UK construction industry.
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 HMRC.
But this will all change from October 1st.
The government wants to stamp out fraud costing millions of pounds per year which happens when suppliers or subcontractors charge VAT but then go into liquidation, or otherwise disappear, without passing the money to HMRC.
So, a new ‘domestic reverse charge’ scheme will stop the transfer of VAT between VAT-registered businesses in the construction industry.
Businesses will effectively lose 20% (the current VAT rate) of their cash flow and, as there is no transitional period for implementing the scheme, companies need to act fast to make sure they can comply with the new rules.
How will it work?
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.
Suppliers will need to issue domestic reverse charge VAT invoices to main contractors and make it clear on their invoices that reverse VAT rules apply and that the customer must account for the VAT.
The new rules continue throughout the supply chain until contractors sell to clients who do not then sell on services.
Who will be affected?
The arrangements apply to individuals or businesses registered for VAT in the UK, that provide services specified under the Construction Industry Scheme (CIS) to other VAT-registered businesses.
Services under the CIS include construction, renovation, demolition, painting, decorating and services such as heating, ventilation and air conditioning.
The scheme does not apply to businesses providing support services such as architecture, consultancy, surveying, machinery, drilling, extraction and the installation of security systems.
If you’re not sure whether you will be affected, it’s worth checking the HMRC website (https://www.gov.uk/what-is-the-construction-industry-scheme) for a full breakdown of services that are included and exempt under CIS.
Mitigating the impact
Many businesses will find it tough to cope with suddenly losing one fifth of their cash flow and need to look internally to see if there are ways to mitigate this loss.
The most effective way to do this would be to see if their payment terms can be changed so that they receive money into their business more quickly.
Companies will also be looking at their budgets to see if any cutbacks can be made or consider restructuring their businesses so that they are not reliant on VAT payments.
It is understandable that, particularly in tough times, businesses do rely on VAT, but really the money is not meant to provide a prop to struggling firms.
Government urged to delay implementation
Major trade bodies in the construction industry are predicting the rule change will cause chaos in the industry because many businesses are not prepared for it and are having a tough time.
They recently wrote to new chancellor Sajid Javid, urging him to delay its introduction until April 2020.
Brian Berry, chief executive of the Federation of Master Builders, said: “The fact that 15 of the leading construction trade bodies have come together to speak to the Government with one voice on this issue shows the extent to which we are concerned.
“We urge the Government to rethink the timing of these changes and announce a delay of up to six months.”
The National Federation of Builders (NFB) pointed out that businesses are facing the 20% drop in cash flow at a time when they can least afford it.
Richard Beresford, chief executive of the NFB, said: “For an industry facing lighter workloads, increasing pressure on cash flow and an already high rate of insolvency, reverse charge VAT could not have come at a worse time.”
Meanwhile tax experts, such as the Chartered Institute of Taxation, have also called for a delay because they believe there has not been enough publicity about the scheme and many businesses are unaware of it.
So far, the government has not shown any intention to delay the changes but, if the lobbying continues, it may soften its stance on a transitional period and be lenient with companies that take time to adjust to the changes.
But don’t bank on it – instead make sure you can comply with the rules by the start of October.
White Hart Associates are specialist accountants for the travel industry. Visit whitehartassociates.com or contact 0208 878 8383 for more information.