How to Prepare for the Construction Industry Vat Reverse Charge

Following delays due to Brexit and Covid-19, the VAT domestic reverse charge for building and construction services is due to come into effect on 1 March 2021, bringing with it significant changes to the way in which VAT is handled for certain kinds of construction services in the UK.

The VAT domestic reverse charge builds on the existing Construction Industry Scheme (CIS) which requires contractors to deduct money from sub-contractors’ payments for tax and NI purposes. The intention is to reduce fraud in the construction industry.

Under the reverse charge scheme, the onus will be on the customer to account for the supplier’s output VAT, rather than the supplier charging it. This will remove the opportunity for the supplier to avoid paying their VAT bill. Broadly, for those working in the construction industry, it means they may no longer need to charge VAT to customers or be charged VAT by suppliers. Of course, the detail is much more complex than this, and there are a number of scenarios in which the scheme does not apply and several ways in which companies must prepare for the change.

When does the VAT domestic reverse charge come into effect?

If the tax point is on or after 1 March 2021, then the reverse charge should be applied. If the tax point is before this, current VAT rules apply, and you should charge VAT at the appropriate rate on your supplies.

Who is affected by the CIS reverse charge?

Firstly, it should be noted that the measures only applies to construction supplies made by a business to a business in which both parties are UK VAT registered and registered for CIS. It also only applies where construction materials and services are supplied at a standard or reduced rate of VAT and if the customer and supplier are not connected, such as being part of the same parent group.

If the customer is not VAT registered, then the reverse charge cannot be applied and standard VAT rules will apply. In this scenario, it’s crucial to make it clear to the supplier in writing that this is the case.

The reverse charge also won’t apply to those classed as end-users, such as the building user or landlord. In addition, "supplies" does not include the supply of staff or workers (e.g. if you are an agency or temporary employment business supplying construction staff).

Despite these exclusions, the reverse charge will affect most services supplied across the sector, so it’s important to be prepared.

What construction services are covered by the reverse charge?

HMRC has released a full list of services that will be affected by the reverse charge. This includes: constructing, altering, repairing, extending, demolishing or dismantling buildings or structures; installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems; and painting or decorating the inside or the external surfaces of any building or structure.

Remember that the reverse charge applies to these services and any construction materials used directly for those services, unlike the CIS scheme, which does not cover materials.

However, the charge does not need to be used for services such as installing security systems, manufacturing building or engineering components or equipment, or for the professional work of architects, surveyors or landscape consultants when such services are supplied on their own.

In general terms, if there is a reverse charge element in a supply, then the whole supply will be subject to the reverse charge. There are however specific rules which confirm whether the invoice should be processed with or without applying the domestic reverse charge. To confirm all the official requirements, please refer to the VAT reverse charge technical guide.

How should I prepare for the reverse charge?

The first step is to ensure those staff members who are responsible for VAT accounting are familiar with the reverse charge and are clear about how it will work. It may also be necessary to speak to your suppliers and customers to ensure that there is agreement over their status and to confirm that the correct procedures will be followed.

It is likely that the changes will also impact cash flow. As affected businesses will no longer receive the gross invoice value from their customers, they will no longer enjoy the cash flow benefit from having the VAT portion of a payment before it’s due to HMRC.

Lastly, check that your accounting software has been updated to ensure the correct invoicing procedures are in place.

Reverse charge invoice processing and VAT reporting

The biggest impact of the changes will be the way in which VAT-registered construction companies record and pay their VAT.

When it comes to VAT payments, the recipient will now be liable for accounting for and paying the VAT to HMRC on behalf of the supplier; the supplier will not make a VAT payment on affected supplies.

In addition to including all the usual information required on a VAT invoice, it will also be necessary to clarify that the reverse charge applies and that the customer is required to account for the VAT. While there is no VAT charged on the invoice, it should state how much VAT is due under the reverse charge or the VAT rate.

Reverse charge supplies are not included and will also not be accounted for under the VAT Flat Rate Scheme. Users of the scheme who receive reverse charge supplies will have to account for the VAT due to HMRC and recover it simultaneously on the same VAT return. In other words the reverse charges are reported in the exact same manner as if you were registered under the standard VAT scheme.

As a simple example, for a subcontractor charging a contractor for £100 worth of building services, the reverse charge treatment in the VAT return is displayed in the following tables.

Reverse charge VAT treatment under the Standard VAT Scheme

	Transactions Not Under Reverse Charge	Transactions Under Reverse Charge
Subcontractor (issues invoice)	Box 1: £20 Box 6: £100	Box 6: £100
Contractor (receives invoice)	Box 4: £20 Box 7: £100	Box 1: £20 Box 4: £20 Box 7: £100

Reverse charge VAT Treatment under the Flat Rate Scheme

The following example uses a flat rate of 10%.

	Transactions Not Under Reverse Charge	Transactions Under Reverse Charge
Subcontractor (issues invoice)	Box 1: £12 Box 6: £120	Box 6: £100
Contractor (receives invoice)	N/A	Box 1: £20 Box 4: £20 Box 7: £100

Note that reporting VAT under the Cash Basis does not apply to domestic reverse charges. Accountsportal will automatically treat the reverse charge VAT under the Accrual Basis. This means the VAT Report will include the invoice before payment.

How to account for the construction industry reverse charge in AccountsPortal

To support the domestic reverse charge requirements, we have added an option for users to automatically generate four new special purpose tax rates. Use of these tax rates on your Sales Invoices, Purchases Invoices, Credit Notes and Bank Transactions will result in the correct VAT reporting result (as displayed in the above tables).

To get started, navigate to the Settings tab, select Tax Rates and then click on the Add Domestic Reverse Charge Tax Rates button. The following new rates will be automatically created:

• 20% Income (Domestic Reverse Charge)
• 5% Income (Domestic Reverse Charge)
• 20% Expense (Domestic Reverse Charge)
• 5% Expense (Domestic Reverse Charge)

Alternatively, you can add each tax rate individually by clicking on the Add New Tax Rate button, and then making sure to select an appropriate Tax Type.

Once the rates have been added, they will be available for use in transactions under the following conditions:

• Your company is located in the United Kingdom (under Financial Settings)
• You are VAT registered as at the date of the transaction
• The date of the transaction is on or after 1 March 2021
• You have selected one of the following VAT treatments for the transaction:
  • Sales/Income transactions: Goods or Services to UK Customer
  • Purchases/Expense transactions: Goods or Services from UK Supplier

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Further Reading

Understanding VAT Thresholds: When Do You Need to Register?

Spring Statement 2022: What it means for small businesses

How to manage the final hospitality VAT rate increase in AccountsPortal