CONSTRUCTION SECTOR: VAT REVERSE CHARGE...STILL HAPPENING
As published in Winslows Digital Tax Magazine, The Wize, Feb 2020. To subscribe for free, please click here >
The VAT reverse charge on construction services may have been delayed…but it is definitely coming. The new implementation date is now 1 October 2020.
What is the ‘reverse charge’?
In a normal transaction subject to VAT, the tax (‘input VAT’) is commercially borne by the customer, who pays it in addition to the price; but it is actually the supplier’s legal responsibility to account to HMRC for this tax (as ‘output VAT).
In a reverse charge scenario, the economics of the charge are unchanged; it is still the customer who bears the tax, but the collection mechanics are reversed as it is the customer who pays the tax directly to HMRC, rather than paying it to the supplier for it to pass to HMRC.
The reverse charge approach has historically applied to certain cross-border transactions but is now to be extended to the construction sector as an anti-fraud measure. This move will add a new compliance burden for purchasers of construction services who are both VAT and CIS (Construction Industry Scheme) registered. It may also have negative cash-flow effects.
How will the reverse charge work?
The reverse charge will only apply to supplies to contractors who themselves make onward supplies; mostly construction businesses which sub-contract some of their work. These construction businesses will now have to pay the VAT on the services they receive from their sub-contractors directly to HMRC.
The reverse charge will not apply to property developers as long as they are ‘end users’, but there may be situations where property developers do make ‘onward supplies’ of construction services. For instance, when they sell a partially constructed building, with a commitment to complete the works after the sale. In such a case, they will be receiving construction services and onward supplying them to the purchaser. They will therefore need to account for the VAT on the supplies they receive (in addition to any VAT due on the supplies they make) to HMRC.
Note that non-construction businesses that are treated as ‘deemed contractors’ are required to report payments under the CIS if their average annual expenditure on construction operations over a three-year period exceeds £1 million. This typically catches businesses with a significant spend on construction such as large retailers, public bodies and property developers. These businesses will however typically be ‘end-users’ for the purpose of the VAT reverse charge and will therefore not have to apply it.
No Splitting of Mixed Costs
Another difference with the CIS is that under the CIS, ‘mixed’ supplies of labour and material require apportionment as only the labour part is covered by the CIS. No such apportionment will happen under the reverse charge; any supply containing an element of labour, however small, will be caught by the reverse charge in its entirety.
Finally, not all construction services are within the scope of the reverse charge; constructions services subject to zero-rating (for instance those relating to residential buildings) are excluded.
Impact for Clients
Large construction businesses, ‘contractors’ in CIS terms, may gain a cash-flow benefit because the VAT they previously had to pay subcontractors in addition to the price (but could not reclaim until the end of the VAT quarter), will now be netted off in the same VAT return.
Subcontractors may, conversely, suffer a loss of cashflow as a result of the reverse charge as they will no longer be able to use the VAT they collect from customers as working capital before they pay it to HMRC.
They may also find that they become repayment traders in that they no longer account for VAT on supplies they make (output tax), but still claim input tax incurred on supplies they have received, so that they get a VAT repayment from HMRC each quarter. Switching from quarterly to monthly returns may be beneficial as it will speed up repayments from HMRC.
Impact for Lawyers
The VAT clauses in precedent contracts relating to transactions subject to the reverse charge will need to be amended. More generally, the VAT clause in any precedent contract including a construction element may need to be re-worded to cover the eventuality of the reverse charge applying.
Existing and potential contracts which include a construction element will also need to be reviewed to identify situations where the reverse charge will/may apply.