The domestic reverse charges will apply to construction services from 1 March 2021. This measure was originally due to start in October 2019, but has been delayed twice due to Brexit and Coronavirus. The construction industry has to be prepared for handling and paying VAT in different way.
What is the VAT domestic reverse charge?
The reverse charge represents a different way we will account for VAT, where the customer will pay the VAT directly to HMRC rather than to the supplier. Domestic part of it refers to being used within a single country.
The purpose of the reverse charge is to eliminate the potential fraudulent activities, where VAT is being reclaimed by customer but 'goes missing' and is not paid back to HMRC.
The new system changes the responsibility to customer to account for VAT, leaving no opportunity for the supplier to disappear before paying the VAT over to HMRC.
Who will be affected by the change?
It applies only to VAT registered businesses, who are supplying or receiving wide range of services in the building trade, primarily those activities covered by Construction Industry Scheme (CIS), which means between subcontractors and contractors in the UK.
All other services will be treated as normal and reverse charges won't apply.
When the new rules won't apply?
The new rules won't apply, if the construction services are provided to the end user. In most cases the end user is the person who owns the building where the works are being done. If the person/company is the end user, they should communicate this to their suppliers.
Additionally, the supplies that are usually not reportable under CIS, won’t be subject to the reverse charges.
What are the conditions for the new rules?
both parties have to be VAT registered
the service has to be standard-rated (20%) or reduced-rated (5%) for VAT purposes
the transaction must be reportable in whole or partially under CIS
services can't be provided to end user
What are the mechanics of the reverse charges?
At the moment, the supplier is raising VAT invoice to customer, who is required to pay in full. The supplier will then pay VAT to HMRC and the customer will reclaim it.
Under the new rules the supplier prepares the invoice, but doesn't include VAT on the invoice, instead they notify the customer of the rate and amount of VAT that they would have charged and must add narrative informing the customer that they are liable to account for VAT.
The wording included on the invoice could be: Reverse charge applies: customer to pay VAT to HMRC.
The customer then reports the VAT as output tax on their VAT and claiming it back as normally. The supplier still records the sale on their VAT return, but with no VAT to be payable to HMRC.
It is suggested, but not required at the moment, that the supplier confirms the customer's VAT number and this could be done here.
The supplier will need to determine on each invoice raised whether or not it has to follow domestic reverse charges. At the same time the customer has to review if this is correct and reject any invoices that don’t follow the new rules.
The new rules are mandatory and everyone in construction industry has to follow them.
Please contact us if you are likely to be affected by these changes and we can work with you to ensure you are ready for the new system when it starts. If you are a sub-contractor using the VAT flat rate scheme, it may be beneficial to leave that scheme as you may be entitled to a VAT refund on your expenses from 1 March 2021.