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Working in the construction industry and registered for VAT; are you clear on how the VAT Domestic Reverse Charge for Construction affects you?
The VAT Domestic Reverse Charge for Building and Construction Services came into force on 1 March 2021, but despite being around for more than a year now, there’s still a lot of confusion around this scheme.
HMRC recognize the scheme is complex and have given a “soft landing” for errors but eventually they will tighten up, so it’s important to get it right.
The reverse charge scheme was introduced as a method to combat Missing Trader VAT fraud in the construction industry. Specifically, where a business charges VAT to their customers, gets paid and then disappears before accounting for the VAT to HMRC.
There is a similar scheme already in place for mobile phones, computer chips and wholesale gas and electricity.
If you’re curious as to how this scheme actually helps HMRC – check out the extra section at the end.
Are you working in the building or construction industry and report through CIS (Construction Industry Scheme) as a contractor or subcontractor?
Are you VAT registered?
If both of these apply to you then you will need to deal with the VAT domestic reverse charge in certain circumstances.
If you are working for a VAT registered CIS contractor and issue a sales invoice that falls under CIS, then it also falls under the domestic reverse charge for VAT.
You will need to makes some changes to the way you prepare your sales invoice.
Include zero rate (0%) VAT on both labour and materials, instead of the usual 20% or 5%.
VAT still needs its own line but your invoice should also show wording stating that the domestic reverse charge for VAT has been applied. HMRC gives some guidance on the wording and invoice layout.
CIS is calculated and deducted from the net labour amount as normal and should still have its own line on the invoice.
But there might be times when the reverse charge does not apply and it’s back to the normal rules of 20% VAT (or the appropriate reduced rate). For example:
Domestic – If you invoice a domestic consumer then reverse charge doesn’t apply as this invoice wouldn’t fall under CIS and they are not VAT registered.
Non VAT registered – If you invoice a CIS contractor who isn’t VAT registered, then reverse charge doesn’t apply.
Services outside CIS – If you invoice a VAT registered CIS contractor for a service that that falls outside CIS, then reverse charge for VAT doesn’t apply either. Reverse charge for VAT follows along with CIS. Some examples include: installing certain elements of security systems, blinds and shutters. If you aren’t sure then the best starting point is the CIS guidance.
End User or Intermediary Supplier – If you invoice a VAT registered CIS contractor and they’ve informed you in writing that they are the “End User” or an “Intermediary supplier” then reverse charge for VAT doesn’t apply.
If you aren’t sure then HMRC has some handy flowcharts to help.
It’s important to be clear about when the reverse charge applies for your subcontractors so you know if you’ve been invoiced correctly. You may also be working as a subcontractor as well as a contractor, in which case may need to apply the reverse charge to your own sales invoices.
If you receive an invoice from a subcontractor that falls under domestic reverse charge, you should not be paying out VAT to the subcontractor. You also need to make sure the invoice is processed correctly for your VAT return.
In your VAT return you need to account for the VAT as if you are both the customer and the supplier so that reverse charge VAT amount appears in your sales VAT and your purchases VAT, but overall the net effect is zero. This is the reverse charge method.
If this sounds horribly complicated, don’t worry, as your digital bookkeeping software should hopefully deal with the domestic reverse charge VAT automatically. However, you may have some initial set up to make sure everything works correctly.
You’ll need to make sure that you or your accountant are familiar with the set up and updates to the invoice and VAT process. You may need to contact your software provider if the process isn’t clear.
By now most people have got to grips with the basics of the scheme but there are still a number of areas that frequently cause complications. This list is by no means comprehensive, as it’s a complex subject, but here some of the most common errors.
If the domestic reverse charge VAT of 0% applies, then it applies to the whole sales invoice, including both the labour and materials elements. This is a common source of confusion as the CIS deduction applies only to the labour element on the invoice and everything else about reverse charge follows along with CIS.
But……., if the labour element is 5% or less of the value of the whole invoice, then there is a 5% disregard and normal VAT rules would apply to the whole invoice.
Hire of equipment and machinery falls outside scope of CIS if it’s equipment only but inside CIS (and therefore subject to reverse charge) if there is an operator or some sort of labour element.
A digger hired with a driver would be under CIS and reverse charge, but a digger hired without a driver would not be under CIS or reverse charge. This can be confusing as bills from the same supplier could be inside or outside CIS and reverse charge depending on the circumstances.
One very common area of confusion is scaffolding. If the scaffolding is supplied, erected and dismantled then it does fall under CIS and reverse charge as there is a labour element involved even if it isn’t explicitly mentioned.
The reduced rate VAT of 5% is used for certain construction projects, such as conversions from non-residential to residential use.
The domestic reverse charge can apply to both standard VAT and reduced rate VAT sales.
The domestic reverse charge applies to UK goods and services. It is not to be confused with the reverse charge for cross border services which is used to account for VAT on non-UK services.
If you use services from outside the UK, for example software and apps, then you may receive some bills with 0% VAT showing the wording “reverse charge”. This reverse charge works in a very similar way, but is a different scheme. It’s likely both types of reverse charge will be set up in your bookkeeping software tax rates.
If you are doing your own bookkeeping, you need to make sure you pick the correct VAT rate in your software. If you accidentally select the wrong type of reverse charge, the transaction might not be processed properly and the relevant rules applied. Again, if in doubt here, speak to your accountant or software provider.
Many businesses use cash accounting for their VAT return. This means sales and purchases are included in the VAT return based on when the money is received or paid, rather than included based on the invoice or bill date (accruals basis VAT accounting).
Cash accounting for VAT can’t be used for sales invoices or bills that are subject to the domestic reverse charge.
But don’t worry. If you do use cash accounting, this doesn’t automatically mean you have to switch to the accruals basis. Many software providers are now able to cope with this rule and your VAT return may end up as a mixture of cash basis for your normal items and accruals for your domestic reverse charge transactions.
However it’s important to check this is the case for your particular digital bookkeeping software and whether there is anything you need to set up to make it function correctly.
Retention payments are common on large-scale construction projects. If you are making or subject to retention, you also need to ensure that these are being dealt with correctly in your VAT software.
The VAT on the retention element is allowed to be delayed until the retention is paid, even if they fall under the reverse charge. This might require changes to the way you manage your retention invoices depending on how your software is set up.
Another limitation of reverse charge invoices and bills is that they are outside the flat rate VAT scheme. They are included in the VAT return separately as if you were on the standard scheme.
Again, this is something that your digital bookkeeping software may be able to deal with automatically but it’s always worth knowing the rules and double checking.
It would also be valuable to work with your accountant to see whether using the Flat Rate scheme is still worthwhile for your business. This will depend on how many reverse charge invoices you are sending or receiving.
There’s no way to cover the full complexity of reverse charge VAT in one blog article, so if you are stuck and need accounting support with your construction VAT, then maybe we can help? Just send us an email to firstname.lastname@example.org to arrange a chat.
Reverse charge is a bit of a strange one and it’s not really intuitive how these changes are actually helping HMRC.
Let’s imagine that Business C and Business S are both VAT registered construction businesses. Business S is working as a subcontractor for Business C, who is the contractor.
Business S charges VAT on their sales invoice to Business C. This shows up on their VAT return as Sales VAT (Output VAT) that they owe to HMRC.
Business C includes the Business S invoice on their VAT return as a Purchase and claims the VAT (Input VAT) from HMRC. Overall Business C has no net gain or loss from the VAT on the invoice, they pay it to Business S and claim it back from HMRC.
If Business S was a Missing Trader, they could collect the whole invoice value from Business C and then disappear without paying their sales VAT to HMRC. Meanwhile Business C has claimed that VAT and HMRC would be left out of pocket. Business S would have stolen the VAT amount from HMRC.
Both businesses have to do things differently under the domestic reverse charge. Business S charge 0% VAT on their sales invoice so only get paid for the net amount from Business C.
Business C applies the reverse charge which means that they include the VAT as both a sale and a purchase.
Before, the Sales VAT (Output VAT) was on the Business S return and the Purchase VAT (Input VAT) was on Business C return. Now Business C is now accounting for the both the Sales VAT and the Purchase VAT (Input and Output VAT) on their return and Business S is not accounting for any of the VAT.
If Business S was a Missing Trader, there is now no benefit for them. Business S doesn’t get paid the VAT because they are charging 0%, therefore there is no VAT for them to steal.
Business C still has no net gain or loss on the invoice from Business S. They didn’t pay any VAT to Business S and don’t claim any VAT back from HMRC.
So the Missing Trader issue is avoided and HMRC doesn’t lose money.
Do you know if your workplace pension scheme contributions are net pay or relief at source?
I suspect that most people can’t answer this off the top of their head! But it’s a question that’s important for the self assessment tax return, particularly if you pay tax above the basic rate. There may be tax savings here if you’re a higher rate or additional rate tax payer.
The important thing to remember is that pension contributions are not taxed. The government wants to encourage you to save for your pension, so this is an incentive. Later, when you take the money out in retirement, some of it will be taxed (but that’s another story).
There are two ways to make sure the pension contributions are not taxed, you can either take the contributions before any tax is paid, or you can take them after tax is paid and then give that tax back. Net pay and relief at source are the most common names for these two basic methods.
Net pay, gross tax basis, salary exchange, salary sacrifice all work in a similar way for income tax. Pension contributions are taken out of the salary before tax.
Salary exchange / salary sacrifice schemes are a bit different in terms of some other aspects of how operate, but that is outside the scope of this article which is just looking at the income tax.
This means that tax relief is direct. No matter what rate of tax will be applied to the salary, the pension contributions are being taken out before that tax is deducted. They are made from untaxed income.
If your workplace pension scheme uses this method for making contributions then there is nothing further that you need to do in your self assessment tax return. You’ve already received all the tax relief.
Relief at source is also very confusingly known as net tax basis. This method is more complex as pension contributions are taken out of the salary after tax and then the tax is effectively given back.
The contributions are taken from your taxed income and then basic rate tax (currently 20%) is added back by the pension scheme provider. You might hear this referred to as the contributions being “grossed up”. The pension scheme provider claims the tax back from HMRC.
Even employees who don’t earn enough to pay tax, get their contributions grossed up so this method can be beneficial for low earners.
Conversely this method is not ideal for higher earners who pay tax above the basic rate. They are making contributions from income that is taxed at 40% or 45% but are only getting 20% tax back automatically. The additional 20% or 25% has to be claimed via the self assessment tax return.
The method applies to the whole workplace pension scheme and can’t be altered for individual employees. It’s unlikely to be something that you can change, unless it’s your own business.
Different types of scheme may be more likely to use one particular method, for example:
The default for these workplace schemes is relief at source (net tax basis) where contributions are taken from the pay after tax and the pension provider adds back the basic rate tax. The employer can choose to use other methods if they want, but the vast majority of People’s Pension or NEST schemes will be relief at source.
Your employer may choose the contribution method based on the salaries levels across the workforce. If most employees are paying higher rate tax then the net pay would be a better option. But in general there are more schemes that use the relief at source method. Some workplaces may operate salary sacrifice / salary exchange which works like net pay in term of the income tax, but slightly different for the national insurance contributions.
If you have a private pension that is not deducted via a workplace payroll, it will be relief at source. This is because when you make personal contributions, they are from your taxed income. If you pay tax above the basic rate, the additional tax relief will need to be claimed in your self assessment.
A limited company can make direct contributions to a director’s private pension. This is different to having a workplace or company pension. It’s also different to using the company bank account to make personal contributions to a private pension. To set up company contributions usually requires completing a specific employer contributions form with the pension provider. In this case there is no personal tax relief to be claimed; instead the pension contributions are a taxable expense for the company which is gaining corporation tax relief.
If you’re a higher rate tax payer on a relief at source scheme, then claiming that extra 20% or 25% via your self assessment will save you money. The tax relief is offset against the tax that you owe on other income to reduce the tax that you owe. Depending on your particular circumstances it will reduce your tax bill, give you a refund or result in a change to your tax code (to reduce the tax paid on your salary).
One thing to note is that you will only get the extra relief on the income that has been taxed above basic rate e.g. if you pay £15,000 into your pension but only £10,000 of your salary has been taxed in the higher rate, then you will only get the extra 20% relief on that higher rate £10,000.
If you are not registered for self assessment then it’s also possible to claim the additional tax relief on your pension contributions by writing to HMRC.
If you’re a basic rate tax payer then it won’t be necessary to enter the contributions in your self assessment as there is no tax benefit to be gained. You’ve already had the 20% tax relief from your pension provider.
However, if you do work with an accountant for your tax return, you should always provide them with the pension figures if you can. Until they’ve done a full assessment of your income, it’s not always clear whether or not the pension contribution information will be required.
You need to include your gross pension contributions on the self assessment tax return.
This is just the contributions that you made, don’t include those made by your employer.
The figure should include the basic rate tax relief element that has been added by your pension provider. You are looking for the grossed up figures for the employee contributions.
If you know what you contributed before the 20% tax relief element (net figure), then you can work out your grossed up figure.
Divided the net figure by 80 then multiply by 100 for the gross figure e.g. £200 net would give £250 gross including the 20% tax relief.
Step 1 is to find out what scheme you are on.
We’ve found that when our clients go to speak to their payroll or pension provider about their pensions it can have varying success because the terminology is pretty confusing. There are many different names, net pay and net tax basis sound similar but are different methods.
What you need to try and find out is whether your pension contributions come from your salary before tax is deducted (net pay / gross tax basis / salary sacrifice) or after tax is deducted (relief at source / net tax basis). You (or your accountant) may be able to work this out by looking at your pay slip, depending on how it’s formatted.
If it’s a Relief at Source scheme, Step 2 will be to get the figures you need for your return.
You need to find out the gross pension contribution figures for the tax year. Again, your accountant will be able to help interpret any reports or information you receive.
If you need support claiming pension tax relief in your self assessment, or aren’t sure whether you need to, then maybe our personal tax team can help? Just get in touch via email on email@example.com or give us a call.
Maybe you’ve never heard the term Making Tax Digital for Income Tax?
Unless you’re a VAT registered business, Making Tax Digital might be something that has never crossed your path. But for many people who submit a self assessment tax return, it’s a name you’ll have to get familiar with very soon.
If you’re a sole trader or property owner, the decisions you make about your business in this tax year (2022-23), could affect whether or not Making Tax Digital will be looming on your horizon.
Making Tax Digital (MTD) is a government initiative and forms a key part of their plans to make it easier for individuals and businesses to get their tax right and keep on top of their affairs. HMRC’s ambition is to become one of the most digitally advanced tax agencies in the world and the Making Tax Digital programme is part of this transformation.
Stage One was Making Tax Digital for VAT (MTD VAT). After a few false starts and delays, the first part of MTD came into force on 1 April 2019 for VAT registered businesses with turnover above the VAT threshold (and any other VAT registered businesses who wanted to join the scheme voluntarily).
This year on 1 April 2022 the scheme was extended to cover all VAT registered businesses whether above or below the VAT threshold.
MTD for VAT involves submitting the quarterly VAT returns electronically via MTD compatible software. For many people this means using cloud software such as Xero or Quickbooks, but there are also many other software solutions.
But HMRC are not content to rest on their VAT laurels, despite some additional delays. They’re very busy working away to get things ready for the roll out of Making Tax Digital for Income Tax (MTD ITSA) on 6 April 2024.
“But that’s ages away”, I hear you say. It may feel that way now, but time has a nasty habit of ticking on very quickly. There are definitely some things that you need to think about now, the most important being, will you be affected?
If you’re a sole trader or a landlord then definitely read on. This is also useful for partnerships too, as you will be included in the next stage. If you just have employment or pension income and/or investment income without any self-employment or property, then MTD ITSA won’t apply to you.
MTD ITSA on 6 April 2024 will affect sole traders and landlords with business or property income over £10,000.
Before you decide that you are below this threshold, there are a few things that you need to bear in mind:
The £10,000 is income, not profit. It’s how much you make in sales or rent, whether or not you make a profit or a loss.
If you have self-employment and property then the £10,000 income is the combination of both. So if you have £6,000 self-employment as a sole trader and £5,000 property rental income then you will be under the threshold for the individual areas, but still in scope overall.
There are some exemptions: people with income under £10,000, trusts, estates, trustees of pension schemes and non-resident companies. Also individuals who can show it is not reasonable or practical for them to use computers or the internet.
Anyone else is in scope. If you are domiciled or resident outside the UK and complete a self-assessment then only the UK self-employment and UK property is in scope.
The initial income assessment to determine if you are over the £10,000 threshold will be made based on the tax year whose filing deadline falls immediately before the start date of MTD ITSA.
This means that if you are currently running a business or renting out property, then it’s this current tax year from April 2022 to March 2023 that will be used for the income assessment. The filing deadline for 2022-23 is 31 Jan 24, so this is the filing deadline immediately before the MTD start date of 6 April 2024.
So business and property decisions and performance in this tax year, will be what affects whether you are initially in scope of MTD ITSA in 2024-25.
The assessment will continue to be made each tax year and you would join in the tax year that starts immediately after the filing date for the year that you go over the threshold.
If you were out of scope initially in 2022-23 but your income grew over £10,000 in 2023-24, then the filing deadline for that year would be 31 Jan 2025 and you would have to join MTD ITSA from April 2025.
If you are in scope based on your income for the tax year 2022-23, from 6 April 2024 you’ll need to:
Keep digital records.
Use MTD compatible software for your submissions.
Send quarterly summary updates of the business income and expenditure to HMRC.
There will be an End of Period statement for each business (self employed and property) at the end of the fourth quarter in March.
There will be a Final Declaration submission for each individual by 31 Jan (similar to the existing self-assessment deadline).
The MTD ITSA quarters will be 5 July, 5 Oct, 5 Jan and 5 April (or can be 30 Jun, 30 Sept, 31 Dec and 31 Mar).
There are separate reports each quarter for each income type and tax. So if you have a VAT registered self employed business and a rental property, that is three quarterly submissions: one for self employed income, one for VAT and one for property income. The VAT quarter timing may be different to the income quarters.
Another thing to note is that different types of property count as different businesses. If you have UK rental property, that is considered to be a separate business to UK furnished holiday let. Other separate property businesses are EEA holiday let (European Economic Area) and overseas rental property.
If you have 3 rental properties and one holiday let then you would have two business to report. One rental property business with the total figures of the 3 rental properties and one holiday let business with the figures from the one holiday let property.
Well – yes and no.
A lot will depend on how organized you are with your business finances (or how organized you can get before your MTD ITSA start date) and whether you are already using compatible software.
Most of the larger accounting and bookkeeping software packages already have an MTD VAT solution in place and are currently trialing their MTD ITSA solutions in conjunction with the HMRC pilot scheme. You can check with your software provider or ask your accountant if you aren’t sure about the product you are using.
If you are already using compatible software and updating your records on a regular basis, then you’ve got a head start. At this stage there is not much more that you need to be doing. Just keep up to date with the latest MTD ITSA developments and software progression so that you’ll be able to learn how to use any relevant new features and how to make the submissions (if you plan to do them yourself).
If you’re used to doing your books annually (either yourself or with your accountant), then this is going to be a big change for you. It would be really beneficial to get into the habit of doing your books more regularly, at least quarterly but ideally monthly. This will set you up for Making Tax Digital and you’ll see other benefits, such as helping to manage cashflow and making more informed business decisions.
If you aren’t currently using any software for your business or property, then now is the time to start investigating your options. If you work with an accountant they’ll be able to help and advise on this and suggest what might be suitable for you. Ideally you want to be using a software solution from April 2023 so that you’re comfortable and familiar with everything well in advance of the roll out date in April 2024. It gives time to overcome any initial teething problems.
If your accountant does your bookkeeping then hopefully they will have plans in hand for the transition and will be able to give you more information.
HMRC is already running a pilot in conjunction with many software providers. Currently the only way to sign up for the pilot is through a software provider. So if you’re keen to get on board now and see what it’s all about, then check your software provider and talk to your accountant.
Partnerships where each individual has income over £10,000 need to sign up by 1 April 2025.
These will be further down the line with no specific date provided yet for Corporation tax.
MTD ITSA is still very much a work in progress with HMRC. The general scheme framework and deadlines have been set and the pilot is underway, but there are currently still some grey areas and finer details to be resolved. As the deadline approaches more and more of the detail will be clarified so it’s worth keeping up to date with MTD ITSA developments through your accountant or software provider. If you have a question that can’t be answered right now, there may be an answer in a few months time.
If this article has got you thinking that you might need to make some changes, then maybe we can help? We’re already working with our self assessment clients to prepare them and make sure they will be fully compliant for Making Tax Digital for Income tax. If you’re ready to take the first steps towards going digital, then we’re ready to support you. Just send us an email to firstname.lastname@example.org and we can chat further.