By implementing a reverse charge for VAT-registered subcontractors, HMRC aimed to combat what it perceived to be a widespread ‘trader’ fraud within the industry. Concern centred on the ease with which a subcontracting company could be established, charge the appropriate rate of VAT on services supplied and then disappear without paying it to HMRC. The changes to the system will mean that VAT-registered subcontractors will not charge the relevant VAT amount on their invoices; instead, the customer employing their services will account for both output and input VAT on their tax returns, with no VAT payment being made to the subcontractor.
All VAT-registered subcontractors and contractors should be preparing for the change. The suppliers affected include (but are not limited to) those falling within the Construction Industry Scheme (CIS). This is drawn widely and includes work carried out in the UK relating to site preparation, alterations, dismantling, construction, repairs, installation, decorating and demolition, among others. The new rules might pose cash flow challenges for subcontractors, but will boost cash flow for the customers, as the VAT is no longer actually paid.
Customers become responsible for accounting for the VAT liability under the domestic reverse charge (DRC) when they are directly involved in supplying construction services to their own customers. Main contractors would typically be subject to the DRC, for example. Other end users, defined as businesses that have commissioned the building work but which do not supply construction services onwards, are excluded from the DRC and will account for VAT normally, paying VAT to the supplier. Private individuals using construction services are also excluded from the DRC.
The most immediate issue with which subcontractors will need to grapple is ensuring that their accounting systems are updated to deal with the changes. They will also have to check whether their suppliers are reverse-charged under the DRC rules, or subject to VAT as usual. This will involve a number of steps, ranging from checking the nature of the service supplied, to understanding the customer’s status for VAT and CIS, to understanding whether the customer qualifies as an end user or is linked to an end user, before then understanding the wider implications such as agreements relating to non-construction services. Only then can the supplier correctly determine whether or not their supply is caught by the DRC and issue a sales invoice with the correctly apportioned values, correct rate(s) of VAT and the correct wording.
Customers will also have their own issues to address. Although their cash flow position may improve, they should consider what terms to include in their contracts with subcontractors. Systems too should be able to distinguish purchases which fall under the DRC from those that do not and identify how to apply and apportion the rate of VAT appropriately and determine those occasions when an end user declaration should be made to suppliers. There are also optional steps which might make life easier for certain customers which should be considered and applied where helpful.
MITIGATION
There are various ways businesses can reorganise their accounting processes in order to soften the blow, but they will need to consult professional advisers to make sure they are set up correctly.
The different types of work, materials, suppliers and customers should be reviewed, and supply chains tested (both buying and selling) to ensure robust systems are in place to get the VAT right. It is worrying and expensive to have HMRC challenge whether VAT was correctly charged on an invoice at any time within the past four years (HMRC investigations are usually capped at four years). If VAT was charged but the DRC should have been applied, HMRC will usually claw back inappropriately-recovered VAT from the customer. If VAT was not charged but should have been, the supplier will be billed.
A review to consider whether the VAT has been accounted for correctly is advisable. There are a variety of ways a construction project might be structured: joint ventures, design and build companies, overseas companies, public-private ventures, sale and leaseback, s106 and other planning gain agreements, and so on. Each have their own complexities when it comes to determining whether the reverse charge applies, which elements of a supply are applicable, and what the appropriate rate of VAT is.
Subcontractors and contractors might also consider a recent addition to the rules that aims to eliminate negligible issues known as the ‘5% disregard’. In certain circumstances the reverse charge element can be set aside, but unfortunately the test is not as simple as whether there is a single supply of a construction service where only a small element would qualify for the reverse charge.
Businesses and their advisers might consider asking a specialist to review their supply chains (ideally at an early stage) to prevent larger issues arising in the years to come, when HMRC begin to question what has been done.
BOX: Example- contractor purchases a water pump from an installer
A main contractor constructs a wholly new office block for a VAT-registered company and purchases services from subcontractors including installation of water pumps. The supply of the works by the main contractor will be standard-rated without the reverse charge and the main contractor should retain evidence on its files that its customer qualifies as an end user. If registered for CIS, the main contractor is likely to receive invoices from its installer subcontractor referring to the reverse charge, and the main contractor will determine the amount of VAT to declare.
This example is often more complicated in reality. For example, the office block might contain some residential accommodation (such as a penthouse suite) which could incorporate part of an existing building or which might have been empty for some time. In that case, different rates of VAT will apply to different elements of the construction and to the installation work. Getting the VAT right will now be the main contractor’s responsibility. It might even be the case that the rate of VAT charged on the sale does not match the rate of VAT accounted for on the purchase.
The installer will have its own issues, such as whether its suppliers are partly reverse-chargeable and partly not, or whether the ‘5% disregard’ rule applies or whether an optional agreement has been reached with the customer for a wider application of the reverse charge. There are even questions as to when a water pump qualifies for the DRC and when it does not, such as when the installer only commissions the pump, inspects it or carries out later repairs to it.