New Domestic Reverse Charge

New Domestic Reverse Charge

From 1 October 2019, there will be a change to the way that VAT is accounted for between VAT registered businesses in relation to VATable construction supplies that fall within the remit of the Construction Industry Scheme (CIS). The domestic reverse charge will affect businesses that supply CIS services to other construction businesses.

Current Practice

Presently, if a sub-contractor makes a supply of construction services to another VAT registered construction business, the sub-contractor will issue an invoice, which the business settles. The business reclaims the VAT paid as input tax and the sub-contractor pays over the VAT as output tax. Sometimes, when a business has paid the invoice and reclaimed the VAT, the sub-contractor does not pay the VAT as output tax to HMRC and so gains a cash advantage.

To combat this fraud, HMRC is introducing a domestic reverse charge. The aim is to shift the liability to account for VAT on supplies of construction services to the customer, rather than the supplier. HMRC estimates that this measure will save them £500m over the next 5 years.

Change

For supplies made on or after 1 October 2019, a sub-contractor will not charge VAT, but the business customer will pay over output tax to HMRC and in the same VAT return, reclaim it. The business customer is in the same position, but no cash moves. This will prevent sub-contractors from disappearing with cash received which should have been paid as output tax to HMRC.

Application of Domestic Reverse Charge

The new rules will only affect supplies that fall within CIS between VAT registered businesses where VAT would have been charged (thus excluding zero-rated supplies). The new rules will affect both services and goods supplied with construction services when there is a single supply. ‘End-Users’ and those connected to End-Users are excluded.

End-User Status

End-Users are businesses that are registered for VAT and receive CIS services, but do not make supplies of building/construction services themselves.

End-Users could include businesses registered for CIS as deemed contractors. For example, a large property investment company incurring significant costs on repairs would receive CIS services, but as its income would consist of rent, as opposed to income generated from providing building services, it would be an End-User and therefore excepted from the domestic reverse charge.

Similarly, although a property developer may build a property to sell and hence be involved in the construction process, as the developer is selling a finished property, rather than providing construction services, it can also be an End-User.

A connection with an End-User will include supplies between landlords and tenants and supplies within a corporate group. If there is a connection with an End-User, the normal VAT rules apply, so VAT is charged where applicable.

It will be the responsibility of the End-User to communicate its status to the supplier in writing. HMRC has set out appropriate wording for End-Users: ‘we are an end user for the purposes of section 55A VAT Act 1994 reverse charge for building and construction services. Please issue us with a  normal VAT invoice, with VAT charged at the appropriate rate. We will not account for the reverse charge’.

Action Plan

Businesses need to identify what services are affected and whether a supply is excluded. If an End-User exists, they should make their status known and a record of their status must be kept by the supplier. The flowchart at Appendix 1 may be useful to determine whether the domestic reverse charge rules apply.

As a result of the new legislation, there are a number of practical issues to consider for both sub- contractors and main contractors operating in the construction industry, for example: additional invoicing requirements, staff training on the rules, adaptations to the accounting software, identifying customer status, treatment of mixed supplies, amending contracts, the interaction with self-billing and the impact on cash-flow.

We can help you review your business transactions and identify changes which may be required to comply with the new domestic reverse charge legislation.

VAT Return Entries & Invoicing

Businesses making a supply of a service subject to the reverse charge should enter the value of the sale in box 6 of the VAT return.

Business customers accounting for the reverse charge will account for output tax in box 1, input tax in box 4 and include the value of the purchase in box 7.

Invoices should include a narrative that makes it clear that the supply is subject to the reverse charge, how much VAT is due under the reverse charge (or the rate of VAT) and state that the business customer will account for VAT.

If you would like to discuss any aspect of these rules in further detail, please feel free to contact us.