From 1 March 2021, HMRC will introduce the VAT reverse charge across the construction industry. This is a new approach for accounting for VAT and will have cash flow, accounting and some admin implications. With careful planning though you can reduce any impact. What is it all about? Here are 10 things you need to know about the VAT reverse charge for the construction industry.
1. If you are a part of the CIS and are VAT registered, it will apply
This is the simple part. If the following applies:
- You are VAT registered
- You use the CIS scheme
Then it will affect you. Be aware of end user or intermediary exclusions. End users are simply the final beneficiary of the construction in question and they themselves produce no onward construction supplies. Intermediaries are individuals / companies associated with that end user, such as a landlord or tenant, or another company within a group. If you’re dealing with one of those, normal VAT rules apply.
If you find your trade is exempt from CIS, it is also most likely exempt from the VAT reverse charge.
2. It will impact your cash flow timing
For subcontractors, this is the number one impact you will feel and may need some planning to overcome, particularly if cash flow is an issue. Why so?
Let’s work through a quick example for a standard-rated CIS subcontractor. Say you issue an invoice for services for £100. Your invoice would look like this:
Services – £100.00
VAT at 20% – £20.00
Gross – £120.00
Currently the contractor will hold back 20% of those services, so you would receive a payment of £100.00 in your bank. Under the new scheme, the contractor is also paying that VAT on your behalf. This means you would only receive £80.00 in your bank. The important point here is the impact to your cash flow. If cash flow is lean for your business and those extra VAT payments are relied upon to pay for suppliers and materials, it will increase the strain on your business. However, because you have already passed on the VAT, it means VAT returns will take on a different form.
Let’s not forget contractors here too. In the short term you will be holding extra cash you did not have to pay across to your supplier, but you will have less recovery as you have not had to pay to your supplier the VAT due, you have held it on their behalf.
3. Subcontractors won’t pay across VAT on those sales
Because you have effectively surrendered the VAT to the contractor, you will find your VAT returns take on a different form. On the VAT return, you would not enter any output VAT, but only disclose the net sales. If you mainly provide services under the Construction Industry Scheme, this could mean you are in a rebate position if you recover input VAT from supplies and services purchased.
Let’s look at another quick example following on from the above, but you additionally have expenses of £50 + VAT in the month. Under the current scheme your VAT would look like this:
Box 1 – Output VAT – £20
Box 4 – Input VAT – £10
Box 5 – Net VAT due – £10
So, £10 due to HMRC. Under the reverse charge, it looks like this:
Box 1 – Output VAT – nil
Box 4 – Input VAT – £10
Box 5 – Net VAT refunded – £10
Remember, you’ve paid across that £20 of VAT to your customer. They’ll account for the VAT for you.
I think this is one positive impact to the supplier. Whilst cash flow is impacted initially, it means you have less to worry about when it comes to VAT return time and can avoid nasty surcharges for late payments. In other words, if you are the kind of person who doesn’t want to worry about sitting on tax liabilities, the reverse charge could be good for you.
4. Contractors will have a higher VAT return outlay
For contractors, it’s slightly different. If you’re purchasing these services, you’ll need to enter the VAT you’ve held back as output VAT. However, you can claim the VAT back, so your net impact is nil. This is because as you never paid the VAT across to the supplier in the first place, you have nothing to recover. The downside here is that your cash outlay will be higher than normal.
Carrying on for the example for the contractor who bought those services, let’s say they have their own sales of £200 + VAT. Currently, it would look like this:
Box 1 – Output VAT – £40
Box 4 – Input VAT – £20
Box 5 – Net VAT due – £20
That’s £40 VAT on sales of £200, less the supplier’s VAT charged. Under the reverse charge though, it would look like this.
Box 1 – Output VAT – £60
Box 4 – Input VAT – £20
Box 5 – Net VAT due – £40
What has happened here is that the return reflects the fact you didn’t need to pay that VAT across to the supplier. You are paying it on behalf of the supplier, so it goes on top of your output VAT. You of course recover it like normal, but now you can see your VAT return is going to be a little higher. The message here is to make sure you keep that extra VAT aside you would have otherwise paid to your supplier. You won’t have the same cash flow issue they do, but if you always spend what’s in your bank, it could create problems.
5. It is designed to combat fraud
Why is this being done in the first place? By way of a bit of background, the VAT reverse charge was put in place to combat fraud. Subcontractors would charge contractors for VAT, but never declare it. This new scheme now holds back the VAT from the subcontractor, nullifying the ability to commit fraud as they will never see the sales VAT in their bank at all.
6. You should inform your customers (contractors) that the reverse charge applies on your invoicing
How you present your invoices will become important. You should continue to list all the correct information on your invoice, such as your VAT number as per normal. However, you need to highlight that VAT should be accounted through the reverse charge.
It is recommended you include some wording on the invoice. Here is an example.
Customer to account to HMRC for the reverse charge output tax on the VAT exclusive price
of items marked ‘reverse charge’ at the relevant VAT rate as shown above.
You should highlight the rate of VAT, which is important to distinguish whether you are providing a standard or reduced rate service. Ensure you only include the amount net of VAT.
An example invoice could be:
Services: £100.00
VAT rate: 20%
VAT £: Reverse Charge
Gross: £100.00
Your accounting software should allow you to correctly set up tax codes and amend invoice templates to ensure all this information is clear. If you have a mixture of CIS and non-CIS customers, I would propose you set up separate invoice templates if possible.
It may be worth discussing this with your customers and suppliers before 1 March just so you are all prepared.
7. Be careful of the nuances
A few less obvious nuances around the reverse charge.
First, if you supply both labour and materials, the entire invoice (supply) is covered by the VAT reverse charge. Not just the labour. This is a major difference versus CIS, where only the labour has tax withheld.
Second, there are transitional rules around projects crossing over the 1 March date. How you charge VAT depends on the tax point and payment date. If you are working on projects crossing the 1st of March, you should ensure you are correctly accounting for the VAT each side of the date.
Similarly, you need to be careful with credit notes. Again, you will need to ensure your credit note has appropriate wording like the above, so the contractor is aware of how to account for the VAT properly.
8. If you provide zero-rated services, it does not apply
If you are providing zero-rated construction services, then as no VAT is due, the reverse charge has no impact here. A good example here is new build housing.
9. Reconsider using the Flat Rate Scheme
The Flat Rate Scheme is not applicable for reverse charge supplies and they must be accounted for normally, but with the flat rate scheme you are restricted on your input recovery. Consequently, remaining on the scheme may not be beneficial if you are missing out on recovering input VAT from purchases. If you are on the flat rate scheme and CIS impacts you, you should seek professional advice as to whether it’s beneficial to continue.
10. It has been deferred before
HMRC intended to launch the VAT reverse charge sooner and it was meant to be in place from the 1st of October 2019. It was deferred to 1 October 2020 and deferred again to 1 March 2021. This was delayed due to lobbying of the government by the construction industry who claimed many were not prepared or aware of the changes. Could it be delayed again? Possibly, but I don’t think HMRC will accept the same complaints again, so I would be prepared for it to go live from 1 March 2021. We will keep an eye on the latest updates to see if HMRC changes their mind again.
How can I prepare for the VAT reverse charge?
The VAT reverse charge is unfortunately just another complexity for businesses to tackle. But, with the right support, planning and tools, you will find the reverse charge quite a painless exercise. Here’s what you should do to make sure you are ready.
- Ensure you are using robust accounting software – Making Tax Digital (MTD) forced a lot of hands on this topic, but I would encourage you to make sure you are using relevant and up-to-date accounting software. This will give you the templates and tax codes to make it work.
- Plan ahead for the initial drop in cash – subcontractors will feel that pinch from March when cash receipts will temporarily fall. Think ahead and plan your cash flow.
- Check to see if the VAT reverse charge applies to you – if in doubt, there is a helpful flow chart that HMRC have produced which you can work through to see if you need to apply the reverse charge.
- Consider monthly VAT returns – HMRC themselves have suggested that monthly VAT returns are a good option to help ease cash flow strains. Whilst there is more admin, it will mean you can recover VAT on purchases quicker.
Finally, a few options from us if you need a hand. We have extensive experience in the construction sector and work with both QuickBooks and Xero. If you want to make the move to the cloud, then we offer our cloud boot camp programme, where we can take you from paper to digital and get you MTD and reverse charge ready. Or, if cash flow is an issue, you could benefit from a bespoke cash flow forecast.
If the VAT reverse charge is going to affect your business and you want to make sure you are ready, get in touch to see how we can help.