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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 tax@cooperfaure.co.uk 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.
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