Anthony Reeves, Associate, Fladgate LLP (firstname.lastname@example.org)
A major overhaul of VAT administration in the construction industry will be introduced later in 2019. For many businesses, the change will now mean that the party who receives the supply (such as a contractor in a property development scenario) will have to pay the VAT directly to HMRC as if it had made the supply to itself, referred to as a ‘reverse charge’.
The key driver behind the change is to combat VAT fraud in the construction sector, where VAT is collected by businesses but is then not repaid to HMRC.
The reverse charge will apply from 1 October 2019, so the construction industry must take steps to get ready. Although HMRC will initially be lenient, businesses not implementing the new rules will face financial penalties.
Typically, the recipient of a supply for VAT pays an amount of VAT to the supplier in addition to the cost of the service. The supplier then accounts to HMRC for this VAT in its VAT return (or recovers it in respect of VAT which it itself has incurred on supplies made to it by other suppliers).
Under the reverse charge, the supplier issues the recipient with a VAT invoice stating that the supply is subject to the reverse charge. The recipient then accounts for the VAT to HMRC through its own VAT return, instead of paying it to the supplier. The recipient can then recover the VAT back as input tax in the usual way if it is a taxable business.
The VAT liability of supplies from a legal perspective (for example, standard or reduced-rated) remains unchanged.
To illustrate the reverse charge in practice, suppose that Business 1 engages Business 2 to provide construction services on a property. VAT will typically be chargeable at 20% on those services and would be a cost incurred by Business 1. Under the reverse charge, Business 1 will pay an amount of VAT for the services directly to HMRC (and can claim that VAT back on its own VAT return if it is a VAT-registered business making its own supplies to others).
The below diagram illustrates how the reverse charge changes the position regarding payment of VAT.
The reverse charge applies by reference to the Construction Industry Scheme (CIS), a tax deduction scheme applying to a wide range of activities in the construction industry. Such activity most obviously includes construction of a building but also includes demolition, repair, installation and a wide range of other related services.
Upon payment for services between businesses which are subject to CIS, the reverse charge will apply all the way through the supply chain up until the services are supplied to the end user. An end user is typically the property owner or a main contractor / developer who sells a newly completed building to the customer.
Importantly then, there are certain areas where the reverse charge will not apply, for example on supplies to end users, between landlords and tenants and supplies of professional services such as architecture, surveying or consulting.
The change will have significant ramifications for the construction industry.
It will be imperative for developers and contractors to examine contracts closely to ensure that the VAT status of services and the businesses to whom they are supplied is clear. For example, suppliers could request a warranty from a recipient confirming they are an end user (so the reverse charge will not apply). There will also be an increased accounting and administrative burden in terms of reporting and record keeping (including appropriate invoicing for services subject to the reverse charge).
Further, cash flow for smaller businesses may be impacted as suppliers will no longer be able to use the VAT they collect from their customers as working capital before paying it over to HMRC. Since the reverse charge will apply to materials supplied along with construction services, this will also bring many more businesses within its scope.
HMRC has acknowledged that the move will require time for adjustment (hence the delay until October 2019), while its approach to genuine mistakes and teething problems in the first six months will be not be too meticulous or heavy handed.
Overall, the reverse charge will significantly impact the way businesses in the construction industry will operate after October 2019.