From 1 October 2020, there will be a major change to the way that VAT is calculated for businesses in the building and construction industries. The change, known as the Domestic Reverse Charge, is being introduced by HMRC to try and tackle fraud in this industry.
Who does it apply to and when?
The Domestic Reverse Charge (reverse charge) will only apply to the supply of services between contractors and sub-contractors, i.e. not the end user. The reverse charge will include the same services currently covered by the Construction Industry Scheme (CIS), however it will now apply to the whole service including any materials provided. If an invoice includes CIS and non-CIS services, the reverse charge will need to be applied to the whole invoice.
The reverse charge will also apply to standard or reduced rated services and amounts dealt with under the reverse charge should not be included under the Cash Accounting or Flat Rate Schemes.
From 1 October 2020, a sub-contractor providing services to a main contractor will not pay any VAT on that sale. Instead, it will be the main contractor who will pay the VAT to HMRC and then recover that VAT. However, it is worth noting that depending on the timing of invoices and VAT returns, this could create a cashflow problem for businesses.
If the main contractor then sells the services onto another contractor, they will not need to pay VAT on that sale. However, if the main contractor’s customer is the end user, then VAT will have to be declared and paid to HMRC under the current rules.
How do I know when the reverse charge applies?
It is important to know the following information to understand whether the reverse charge applies:
- Is the supply covered by CIS?
- Is the supply standard or reduced rated for VAT?
- Is the customer VAT registered?
- Is the customer CIS registered?
- Is the customer the end user?
If the answer to any of the above is ‘no’, the reverse charge does not apply.
NB. If you supply services, you are the one responsible for checking if your customers are registered for VAT and CIS.
Will I pay more VAT as a result of the reverse charge?
Some businesses will find that they have more VAT to pay as a result of the changes, whilst others may be able to reclaim VAT from HMRC. If the latter is the case, it may be beneficial to change to monthly VAT returns so you can reclaim VAT more quickly.
How do I assess existing contracts on 01 October 2020?
Some businesses will have existing contracts with the same subcontractor when the changes come into force. To make the transition easier, HMRC will allow you to apply the reverse charge to all existing contracts with that subcontractor, providing more than 5% of the contracts (by volume or value) fall under the reverse charge rules.
There are also transitional rules for invoices that are issued before 1 October 2020 but are not settled until after 1 October 2020. As these are quite complicated, we would advise anyone who may be affected by this scenario to contact us directly.
For new contracts starting after 1 October 2020 you will need to decide whether the reverse charge applies from the outset for each individual contract.
It is important to be aware of any change in status of your customers during a contract. For example, an end user may decide to sell on the services, in which case you may have to apply the reverse charge from the date of that change.
The above information only summarises the new rules that are being introduced. Changes made in relation to taxation can be complex and result in different outcomes for different individuals. We would therefore encourage you to raise any questions you may have in relation to the Domestic Reverse Charge with the partner who manages your affairs. We will then be able to provide the appropriate guidance and clarify any concerns you may have.
If you are an SME or a start up and are not already a client but would like to more information, then please contact us for an free initial consultation.