It seems that, without further ado, and notwithstanding the negative impact on small and medium sized construction firms during these already challenging times, the VAT domestic reverse charge on construction services will come into force on 1 March 2021. This note explains why the change is coming, who will be affected and how it will work.
What change is happening?
There will be a reverse VAT charge in respect of business to business supplies of construction services where the recipient is VAT registered and is not the final consumer.
The normal VAT position is that a supplier must account directly to HMRC for VAT on its supplies of goods and services. If the reverse charge applies, then the customer is responsible for accounting to HMRC instead. That means the supplier doesn’t need to ask the customer to pay VAT, but they should still provide a VAT invoice with an annotation that the reverse charge applies.
The customer can still recover the VAT under the normal VAT recovery rules.
When will this apply?
The new rules apply to supplies with tax points arising from 1 March 2021. Implementation has been delayed twice because the construction industry (i) needed more time to prepare for the change, (ii) was already busy preparing for Brexit, and (iii) was dealing with the impacts of the coronavirus pandemic.
Why are the rules changing?
Simply, to prevent VAT avoidance in the construction industry. Suppliers in the industry have been known to charge VAT to their customers, but then fail to pass it on to HMRC. To combat this, the responsibility to account to HMRC for VAT will pass to the customer – which is why it is called a “reverse charge”. The domestic reverse charge ties in with the existing Construction Industry Scheme (CIS), which is another regime to prevent tax avoidance in the construction industry where tax is deducted at source from payments for construction work.
Who will have to apply the reverse charge?
Recipients of construction services who:
- are VAT registered (or should be VAT registered), and
- will make onward supplies of the construction services to unconnected parties,
will account for VAT directly to HMRC, instead of paying it to the supplier as usual.
For example, a large developer which receives supplies from a smaller scaffolding specialist contractor would need to account for the VAT directly to HMRC instead of paying it over to the scaffold contractor. The developer would recover this VAT amount in the usual way. Meanwhile, the contractor will no longer be able to use the VAT income to ameliorate cash flow.
What is a “construction service”?
The new VAT rules take the definition of construction service from the well-established CIS rules, broadly:
- construction, alteration, repair, extension, demolition or dismantling of buildings or structures
- Installation of heating, lighting, air-con and drainage systems
- Painting and decorating
- Prep work for the above, such as cleaning, site clearance, laying foundations and erecting scaffolding.
The industry is generally familiar with CIS so suppliers should find it relatively easy to discern whether the reverse charge will apply.
Mixed supplies which include the above services along with other supplies will be treated as a construction service subject to the reverse charge, even if the construction service is only an ancillary element of the overall supply (subject to a ‘5% disregard’, where if the reverse charge part of the supply is 5% or less of the value of the whole supply this can be disregarded).
Who will not be affected by the new domestic reverse charge?
- Recipients who are not VAT registered (nor ought to be VAT registered),
- Recipients who are contractors not required to make CIS returns,
- Recipients who are charities (because the service doesn’t count as a “construction service” under the CIS rules if the recipient is a charity – but watch out for trading subsidiaries which are not themselves charitable),
- Recipients who will not make an onward supply of the construction service (“end users”), and
- Recipients who will make an onward supply of the construction service, but only to connected parties (“intermediaries”, but they can also call themselves “end users” for simplicity).
Written notification of end-user/intermediary status
End users and intermediaries will be required to provide written notification of their status (without which, the supplier should assume the reverse charge applies). This notification may be within the contract, heads of terms, letter, email etc. The written notification should be kept as part of the supplier’s records and it should be clear which supplies the notification specifically relates to.
HMRC’s suggested wording is:
‘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.’
In most cases the reverse charge will not affect Housing Associations, because:
- Zero-rated supplies are outside the scope of the reverse charge (i.e. new housing)
- Housing associations will usually be the end user (i.e. they will not typically make onward supplies of construction services beyond their group)
- Services to charities do not fall under CIS and therefore the domestic reverse charge will not bite.
How can we help?
Our team is well placed to help clients:
- Assess whether the reverse charge applies to them as a recipient, or to the recipient of construction services supplied by them, and
- Update the VAT drafting in their contracts, if necessary.