The domestic reverse vat charge for the construction industry will seep into the UK taxation system almost a year from now i.e. as of 1 October 2020 onwards.
Ever wondered why it is coming into the picture? Why is it even required?
The Construction Industry Scheme (CIS) as we know was introduced to address the direct tax fraud. The government has long been looking for similar plan options to address VAT hoaxes. Thus, to combat the ever-rising VAT scams in the industry VAT reverse charge is set to be introduced. Currently, suppliers in this industry charge their customers VAT but effectively fail to pay it over to HMRC. In a bid to the outcome, the government is now all set to roll out VAT reverse charge in the construction industry. As of October 2020, the customers are to pay the VAT directly to HMRC instead of the supplier. Essentially, money paid as VAT is to cease to flow between businesses, it is to be paid directly to the government. In turn, the buyer can then take credit of the VAT so paid. Overall it has a neutral effect on the customer.
CONDITIONS FOR APPLYING TO REVERSE CHARGE VAT
Reverse charge on construction services applies only if all the following conditions are met:
- The services are such, which are needed to be reported as part of CIS.
- The services are supplied at the standard or reduced rates.
- The customer is registered for UK VAT.
- The customer is registered for CIS.
- The customer is an intermediary who has no connection with the end-user.
- The customer does not have any interest in land, E.g. supplier and recipient do not share the relationship of landlord and tenant etc.
- Identify if the services provided are being covered under reverse charge.
- Distinguish if the customer is an intermediary/sub-contractor or end-user. Remember, end-users, are businesses, or groups of businesses, that do not make onward supplies of the building and construction services.
- Check if the customer is registered under VAT.
- Update the accounting software to deal with reverse charge transactions.
- Train the staff regarding applicability and operation of the reverse charge mechanism.
HOW TO IDENTIFY IF ONGOING CONTRACTS FALL UNDER REVERSE CHARGE?
For ongoing contracts on 1st October 2020, it is important to determine whether they fall under the reverse charge scheme or not. To mitigate the VAT accounting treatment in such cases, HMRC has suggested that a similar treatment should be given to all contracts with a particular sub-contractor. So, if the contractor looks across all contracts, signed within the industry, involved with a sub-contractor with whose reverse charge applies to more than 5% of contracts (either by volume or value), then the VAT reverse charge may be applied to all the contracts. This would help in avoiding uncertainty and delay to payments while each contract is checked for reverse charge applicability.
For contracts starting after 1 October 2020, the businesses need to decide whether the reverse charge applies from the beginning of the contract itself.
WHAT IS CONTRACTOR SUPPOSED TO DO?
If the contractor provides services to a sub-contractor, then the amount of VAT required to be paid by sub-contractor under reverse charge must be clearly stated on the VAT invoice issued by the contractor. This amount should not be included in the total VAT charge. Instead, it can be shown as a reference on the invoice to make it clear that the reverse charge applies and that the sub-contractor is required to account for the VAT. E.g. Stating “reverse charge: VAT Act 1994 Section 55A applies” or “reverse charge: Customer to pay the VAT to HMRC” etc.
WHAT IS SUBCONTRACTOR SUPPOSED TO DO?
The sub-contractor should confirm to the contractor that he is not the end-user. Moreover, once he has received the service and invoice, raised in his favour, he must consider for reverse charge VAT on the VAT return for the period in which he has received construction services. He can reclaim this VAT input tax on the same return as it is accounted for.
LIBERAL APPROACH OF HMRC IN THE EARLY STAGE
The HMRC shall adopt a flexible approach while dealing with errors for the first 6 months from the onset of this legislation. No penalties shall be levied in cases that contractors are adjusting themselves to comply with the scheme except in circumstances that they detect any evidence of exploitation of the legislation. During this period any errors that get detected need be corrected as soon as possible, as the longer under-declared or overcharged sums remain outstanding the more difficult it may be to correct or recover them.
The reverse charge does not apply if the service is zero-rated under VAT. E.g. Construction and first freehold or long leasehold sale of new domestic buildings etc.
A mixed supply, which includes construction services and other supply (even if that supply would be excluded if it were being supplied separately), is treated as a supply of construction services for reverse charge VAT, for example providing both design and construction services. In such a case, the amount charged for these services would be subject to reverse charge. This is to make the process simpler for both supplier and customer by avoiding the need to distribute or split out the supply.
Change of VAT treatment during a contract
If the original services are not covered by the reverse VAT charge, but following services fall within the scope, charges for services in future would be subject to reverse charge. The new treatment will apply at the point the customer’s circumstances change. Companies will, therefore, be required to carry out an ongoing review of the VAT position throughout a construction project.
If this change happens during an invoice period (where there would be one invoice including both reverse charge and normal VAT rules), the supplier can opt to change to the new treatment for the entire invoice period or to wait until the next invoice period before changing to the new treatment.
Businesses supplying staff
Employment businesses that provide staff and are responsible for paying temporary workers are also exemptions to this legislation.
To avoid any sort of disruption once the reverse charge on construction services comes on the floor, it’s important to understand it and check its applicability on the concerned businesses. It is important to be well prepared ahead of time. If this legislation applies to a business, then they need to review each of their contracts following the legislation and be all set to abide by the requirements of the same. This will ensure an effective and smooth rollout of the new legislation.