HMRC has updated the draft legislation for its new VAT domestic reverse charge regime for the construction industry, which will require the recipient rather than the supplier to account for the VAT due on certain construction services.
The update confirms that the reverse charge will come into force on 1 October 2019 as originally planned and that the reverse charge will cover more than just construction services. The update has also confirmed that the value of such reverse charge services will not count towards the VAT registration threshold for the business which is good news for smaller businesses and that if there has already been a domestic reverse charge supply on a construction site any subsequent supplies on that site between the same parties can be treated as domestic reverse charge supplies
The domestic reverse charge was first proposed and consulted on in 2017 and aims to combat missing trader fraud in the construction sector. It is similar to the domestic reverse charge that is currently in place for the sale of computer chips and mobile phones.
Under the new regime, a VAT-registered business, which supplies certain construction services to another VAT-registered business for onward sale, will be required to issue a VAT invoice stating that the service is subject to the domestic reverse charge.
The recipient must then account for the VAT on that supply itself through its VAT return at the appropriate rate, instead of paying the VAT to the supplier. The recipient may recover that VAT amount as input tax, subject to the normal rules.
Which services will it apply to?
The new domestic reverse charge will apply to B2B supplies of those services between VAT registered businesses where the recipient then makes an onward supply of the same construction services. The legislation is designed so that if there is a reverse charge element in a supply then the whole supply will be subject to the domestic reverse charge.
Any subsequent supplies on a construction where the domestic reverse charge has applied previously, may also be covered by the domestic reverse charge, if both parties agree. This has been introduced to speed up the decision making process on whether the domestic reverse charge should apply.
Therefore, it will not apply where:
· Services are supplied to the end user, such as the property owner, or directly to a main contractor that sells a newly completed building to the customer
· The recipient makes onward supplies of those construction services to a connected company
· The supplier and recipient are landlord and tenant or vice versa, or
· The supplies are zero-rated.
The Government’s original proposal stated that the reverse charge would apply to ‘labour only’ supplies of construction services. However, HMRC’s now states that it will also cover the provision of construction services that includes materials. This will bring many more construction businesses into the reverse charge than first thought.
The receipt of the reverse charge service will not count the VAT registration threshold for a UK established business that is not currently required to be registered for VAT. In this respect it differs from the reverse charge due on services purchased by a business from outside the UK, where the value of such services are counted when determining if the VAT registration threshold has been exceeded. This change will help a number of businesses in the sector whose turnover is close to the VAT registration threshold and such businesses will be charged VAT by the supplier as at present.
How will this affect construction businesses?
HMRC acknowledges that the impact on the industry is potentially significant – construction businesses must first adapt their accounting systems to process reverse charge supplies then make ongoing checks to ensure that supplies and purchases are correctly treated. HMRC also notes that some businesses may suffer a loss of cash flow where VAT is no longer charged, ie they will no longer be able to use the VAT they collect from customers as working capital before they pay it over to HMRC.
The reverse charge could also create other issues for operators beyond those highlighted by HMRC, including the following:
· Depending on their nature, construction services may be subject to VAT at the standard rate of 20%, the reduced rate of 5% or zero-rated. Under the new reverse charge, the recipient would be responsible for identifying the correct VAT treatment of a service provided to them by another contractor, which may not always be simple to verify.
· To determine whether the reverse charge applies, it will be necessary for contractors to disclose to their subcontractor whether or not they are at the end of the supply chain – information which could, in some cases, be commercially sensitive.
· If the end user does not provide its supplier with confirmation of its end user status, the end user will be responsible for accounting for the domestic reverse charge. However, it is not clear if there will be any penalties for not confirming end user status or what enforcement action HMRC may take on this issue.
What action should construction businesses take?
Construction businesses should:
· Review supplies made to and received from other VAT registered contractors to establish whether these will be subject to a reverse charge from October 2019
· Consider the adaptions that will need to be made to their accounting systems to deal with this change and
· Consider the impact on their cash flow from October 2019 of not receiving the VAT from their customer and if there are any other ways to mitigate this impact.