The start of the VAT domestic reverse charge for the building and construction services has been delayed for one year and is now scheduled to start on 1 October 2020. Business need to use this time window to ensure they are prepared.
It still means that the customer receiving the service will have to pay the VAT due to HMRC instead of paying the supplier. It will apply to individuals or businesses registered for VAT in the UK. The reverse charge will affect supplies of building and construction services that need to be reported under CIS at the standard or reduced rates.
It will alter VAT returns, invoicing and debtor requirements for both contractors and subcontractors. These businesses now have a further year to prepare, including amending contracts, considering the impact on cashflow and considering how they will deal with the different ways of working.
The guidance states that:
- ‘if you’re a contractor you’ll also need to review all your contracts with sub-contractors, to decide if the reverse charge will apply to the services you receive under your contracts. You’ll need to notify your suppliers if it will.
- if you’re a sub-contractor you’ll also need to contact your customers to get confirmation from them if the reverse charge will apply, including confirming if the customer is an end user or intermediary supplier.’
The following are some of the most frequently asked questions in relation to DRC to assist you with the practical application of the new VAT regime.
Does the DRC apply to every provider of construction services?
No. Broadly, DRC applies to VAT registered traders providing construction services to VAT registered entities who provide an onward supply of these services.
DRC will not apply where:
- services are supplied to end user, such as property owner, developer or main contractor, that sells a newly completed building to a customer
- recipient makes onward supplies to a connected company
- supplier and recipient are landlord and tenant and vice versa
- supplies are zero rated.
What is meant by ‘onward supply’ of construction services?
If a project for an end client is delivered through a chain of subcontractor transactions, no VAT will be charged by any of the subcontractors in the chain until the final stage where a service is supplied to a main contractor, an end client or a developer (end user).
For example, subcontractor 1 is engaged by subcontractor 2 to dig building foundations. Supplier 2 carries out insulation and reinforcement work on the excavated ground for supplier 3. Supplier 3 receives reinforced insulated foundations to continue construction further. Construction services are provided onwards by contractor 1 to contractor 2 and then contractor 3. No VAT will be charged by subcontractor 1, 2 and 3, until further down the line the service is provided to the main contractor responsible to deliver the finished construction project.
Does DRC apply to all construction services?
DRC applies to the same services as those that are currently covered by the Construction Industry Scheme.
In general terms, how does DRC work?
Subcontractor 1 providing construction services to Subcontractor 2 does not charge VAT on its invoice.
Subcontractor 2 entity ‘charges itself’ output VAT and recovers it as input tax on the same return – the input and output VAT cancel out, with NIL impact on subcontractor 2 VAT position.
What should a correct DRC invoice show?
Where DRC applies, the invoice raised should state how much VAT is due under the reverse charge, or the rate of VAT if the VAT amount cannot be shown.
VAT should not be included in the amount charged to the customer.
The invoice should make it clear that the domestic reverse charge applies and that the customer is required to account for the VAT. Suggested wording: ‘Reverse charge VATA 1994 section 55A applies’.
I carried out a refurbishment of a client’s company offices. Do I need to charge VAT, or do I fall under DRC and therefore not charge VAT?
As the company is an end user (it will operate from the offices) DRC does not apply and VAT must be charged.
We provide construction workers for construction projects. Do our services fall under DRC?
No, supply of staff does not constitute the supply of construction services.
As a construction business, are we obliged to verify whether our client is an end user and therefore DRC does not apply?
Where customer status not clear, the supplier of construction services should ask the customer if they are an end user or intermediary supplier and keep a record of the answer. It is the responsibility of the customer to make the supplier aware that they are an end user.
In the absence of confirmation from the customer that they are an end user, the supplier will need to assume reverse charge rules will apply.
How strict will HMRC be in policing the application of DRC and penalising for non-compliance?
HMRC envisage a light-touch approach for the first six months after DRC comes in, if it is evident that the taxpayer acted in in good faith and tried to comply with legislation. However, HMRC expects to assess for errors where businesses take advantage of the scheme by not applying it correctly, for example where it is evident that an end user incorrectly failed to issue a confirmation to generate a cash flow advantage. Penalties for DRC breaches have not yet been formally confirmed.
How should an error be corrected?
If no written confirmation from a customer has been obtained, and DRC is applied incorrectly, the customer should notify the supplier that it is an end user and request a corrected invoice.
If a supplier charges VAT where DRC should apply, there is a liability on the supplier for the incorrectly charged VAT, while at the same time the customer will not be able to recover the VAT, as it had been charged incorrectly.
We have ceased to be an end user half-way during the contract and will now provide construction services outwards. What is the correct process to handle this change from the DRC perspective when we are invoiced by our subcontractor?
As a customer ceasing to be an end user, you should notify the supplier. The new VAT treatment will apply from the point the customer’s circumstances changed.
If the change happened during an invoice period where there would be one invoice including reverse charge rules and one following normal VAT rules, your supplier can opt to change to the new treatment for the entire invoice period or wait until the next invoice period before changing to the new treatment.
Currently there is no guidance from HMRC on what would happen in a reverse situation where a customer becomes an end user half-way through the contract.
Does DRC affect VAT recovery for a trader who will no longer charge output VAT, but incurs input VAT?
No. The recovery of input VAT is not affected. However, where as a result of DRC applying you will find yourself in a VAT repayment position, HMRC recommends a switch to monthly returns.
How will DRC affect the flat rate scheme?
It is likely that the flat rate scheme will no longer be beneficial to a supplier of construction services on flat rate.
How will the new rules DRC affect me as a subcontractor?
Not being able to charge VAT on an onward supply of construction services will remove the positive cash flow advantage. If you are a small or medium construction company operating below the main contractor and on low margins, your available working capital buffer may significantly decrease as the upfront funding equal to as much as 20% of your revenue for up to four months is removed.
For main contractors, DRC will result in potentially sensitive disclosure of being at the end of the supply chain. This may affect the negotiation position.
DRC will force a review of supplies made to and received from VAT registered contractors to establish whether these will be subject to a reverse charge from October 2020.
Traders will need to adapt accounting systems to process reverse charge supplies and to make ongoing checks at a later stage to ensure that supplies and purchases are correctly treated.
Article from ACCA In Practice