A&M Tax Advisor Update
The VAT domestic reverse charge (DRC) for building and construction services will become effective from 1 March 2021. Affected businesses (both suppliers and customers) will therefore now need to ensure they are fully prepared for the upcoming changes and reflect the correct VAT position within their contracts, invoicing and accounting processes. Our article highlights the main changes and what businesses will need to be doing to meet HMRC’s requirements in respect of existing contracts which span 1 March 2021 and contracts going forward. This is likely to bring significant changes to your accounting and cashflow position, so you need to be ready for this. This DRC may impact those who would not typically consider themselves to be involved in construction services. Our next article will include details of the types of services impacted by DRC.
As highlighted in our previous article, the introduction of the DRC from 1 March 2021 will impact most UK VAT registered construction businesses. In particular, those which supply and/or receive certain standard or reduced-rate specified services (together with any building and construction materials used directly in those services) that are required to be reported under the Construction Industry Scheme (CIS). As the DRC is a domestic reverse charge, the U.K.’s exit from the EU will not impact this.
There are various specific exclusions from the scope of the DRC set out within HMRC’s guidance. For example, professional architect, surveyor and certain consultants’ services.
Will this apply to me?
If you are a U.K. VAT registered business (e.g. contractor or subcontractor) making or receiving certain standard or reduced rate construction services which are reported under the CIS, the DRC will apply to you. Where mixed supplies are made (i.e. only certain elements are DRC supplies), HMRC’s guidance indicates that the DRC should usually be applied to the entire supply, subject to a 5% disregard. Where the DRC applies, the customer (rather than the supplier) will be responsible for accounting for the VAT due to HMRC on the supply. This means that the customer will no longer physically pay VAT to the supplier (e.g. to its subcontractors) but will only pay for the cost of the construction work (and materials) net of CIS deductions for tax and NI.
If you only supply building and construction materials without construction services, or if you only make zero rated supplies, you will not be affected by the changes and the normal VAT rules will apply.
The DRC will also not apply to end users or persons connected to end users (e.g. intermediary suppliers such as landlords or tenants), in which case the normal VAT rules will similarly apply.
What if I receive supplies and I am not U.K. VAT registered?
Non VAT registered businesses receiving construction services will need to inform the supplier in writing of their VAT registration status as they will be charged VAT under the normal rules.
What if I have construction projects spanning the changes?
The normal tax point rules should be followed, therefore whether or not the DRC should be applied to services under your contract will depend on whether an invoice has been issued or payment received before 1 March 2021, in which case the normal VAT rules will apply. Any supplies with tax points arising after 1 March 2021 will be subject to the DRC.
As a supplier, what practical changes do I need to make and what should my invoices say?
Suppliers (e.g. subcontractors) providing standard or reduced rated CIS regulated construction services will firstly need to check if their customers are VAT/CIS registered and/or an end user/intermediary. For customers who confirm they are VAT registered and not end users/ intermediaries, suppliers must issue invoices with wording such as ‘reverse charge : VAT Act 1994 section 55A applies – customer to pay the VAT to HMRC’, alongside all of the usual VAT invoice information.
You will need to obtain written confirmation from any customers who are end users/intermediaries and keep this on file. Your invoices to such end users/intermediaries should then be issued as before, under the normal rules, as the DRC will not apply.
If your existing invoicing software has not already been updated with the capability to issue DRC VAT invoices, you will need to update your systems to ensure that the correct wording is applied to your invoices from 1 March 2021 onwards.
As your customers will be paying VAT on your supplies directly to HMRC as part of the DRC accounting, you will no longer receive payment of this VAT, so you will need to reflect this within your cash flow calculations. You will also need to ensure that your accounting systems are updated to record only the net value of DRC supplies in box 6 of your VAT return (i.e. and no VAT accounted for in box 1).
If most of your supplies are DRC supplies, you may move into a regular VAT repayment position. In this case, you may benefit by switching to monthly VAT returns so you receive repayments sooner.
What do businesses receiving DRC services need to do to be ready for the changes?
If you are a VAT registered business customer (e.g. contractor) who buys in CIS regulated standard or reduced rate construction services, you will need to correctly account for VAT under the DRC when you receive associated invoices from suppliers. On receipt of invoices, you should check that the services described properly fall within the DRC and that the wording on the invoices is correct. This is very important as the risk of accounting for VAT is now shifted to you, the customer, so you need to check that the services you receive have had the correct VAT liability applied (for example, that they have been correctly treated as standard/reduced rated and are not actually zero rated), to ensure you are not over or under-accounting for VAT.
You will need to ensure that your accounting systems and processes are updated so that VAT is properly accounted for on DRC supplies and is paid to HMRC at the correct time. You should account for VAT as both output VAT in box 1 and input VAT in box 4 (subject to the normal recovery rules) and include the net value in boxes 6 and 7 of your VAT return. If you are a fully taxable business, accounting for VAT under the DRC should have a nil net VAT effect.
As you will be accounting for the VAT on DRC supplies you receive directly to HMRC through your VAT returns, you should update your payment procedures to ensure that you do not pay any VAT amounts on such supplies to your suppliers. This should positively impact your cash flow given that you will be both paying and recovering the VAT from HMRC at the same time.
If you are an end user/intermediary, you must notify your suppliers of this in writing using wording along the following lines:”We are an end user for the purposes of section 55A VAT Act 1994 reverse charge for building and construction services. Please issue us with a normal VAT invoice, with VAT charged at the appropriate rate. We will not account for the reverse charge.”
Without such written notification, your supplier will assume the DRC applies and will not charge you VAT under the normal rules.
What if I make supplies of construction staff/services – does this fall within the DRC?
Employment businesses supplying (and who are responsible for paying) temporary workers will fall outside of the DRC as this is not considered to be the supply of building or construction services and the workers are not being paid by the construction business itself. These are treated as supplies of staff under the normal rules. However, the DRC does apply to services provided by labour only sub-contractors (as they are responsible for the works carried out).
Penalties for inaccuracies
HMRC will be applying a light touch approach to penalties for any non-deliberate errors in the first 6 months where businesses have acted in good faith and says in its guidance that “if there is doubt whether a type of work falls within the definition of building and construction services, as long as the recipient is VAT registered and the payments are subject to CIS, the reverse charge should apply.”
Other practical issues
You can use HMRC’s website to check if businesses are VAT registered using: https://www.tax.service.gov.uk/check-vat-number/enter-vat-details.
HMRC does not require businesses to verify the CIS registration of existing customers but businesses should check that existing documentation (e.g. deductions certificates) is correct and current. Subcontractors can verify CIS registration by requesting details from the contractor and should keep copies of any documentation on file. Contractors can use the CIS verification system or their own CIS software to verify any new subcontractors (using names, UTR and NI number/company registration number).
DRC supplies should not be accounted for under the flat rate scheme, therefore flat rate scheme users who receive DRC supplies will need to consider whether the flat rate scheme is still beneficial or if they would be better moving to use of the standard scheme.
What should I be doing now?
If you are involved in projects involving construction services that will end after 1 March 2021, the DRC is likely to have a significant impact on your accounting, invoicing and cashflow position. You will therefore need to consider how the introduction of the DRC will affect you and make plans to ensure you are ready for the changes.
If you have not already updated your IT systems, prepared your staff for the associated invoicing and payment changes, you will need to do so now to ensure that you are correctly accounting for VAT from 1 March 2021 onwards. Although HMRC will be adopting a light touch in the first 6 months, any deliberate errors are likely to attract penalties therefore it is important that attention is paid to this now so that there is a smooth transition for your business.
You may want to contact your regular suppliers /subcontractors to discuss and agree any changes required and to reflect these within any contracts if needed.
The DRC changes will be quickly followed by IR35 and CIS technical changes in April that you will also need to be aware of. As businesses within the sector have been struggling over the last year due to COVID and the level of activity is reduced, you may have overlooked this. Our multi-disciplinary teams can help you with these challenges.
If you would like to discuss further in relation to your own position, please contact us or your usual A&M VAT adviser.
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