There’s a big change in store for the construction industry and the way payments are made to VAT-registered sub-contractors.
The reverse charge will mean that the main contractor on a project will be liable to account for the VAT for ‘specified services’, rather than the supplier.
The good news is that the industry has just been given a little longer to get used to the implications.
The reverse charge was due to take effect on 1st October 2019. However, with no-deal Brexit preparations going into overdrive, HMRC has just announced it will delay for a year until 1 October 2020.
So there’s a little more time to prepare. Here’s what you need to know:
How the charge will work
The reverse charge is an anti-fraud measure designed to ensure that the VAT due actually reaches HMRC. It has already been introduced for telecommunication services, mobile phones and computer chips.
The charge will apply throughout the CIS supply chain until the customer receiving the supply is no longer a ‘business making supplies of specified services’. These businesses and individuals are referred to by HMRC as the ‘end-user(s)’.
HMRC and government have indicated that by the end of the 2023/24 tax year, the introduction of the reverse charge will collect in excess of £495m of tax revenue that historically would have been lost to the public purse.
Reverse charges shift liability
The reverse charge mechanism shifts the liability for accounting for output VAT from the supplier (sub-contractor) to the customer (main contractor). Ultimately, this prevents the supplier from absconding with the VAT element and not paying it over to HMRC.
The reverse charge will not encompass businesses that supply specified services to connected parties within a corporate group structure or with a common interest in land. In such circumstances, the supplies in question will revert to normal VAT accounting rules.
Effects on non-construction firms
While the obligations under CIS usually only apply to those operating in the construction industry, non-construction businesses become ‘deemed contractors’ if their average annual expenditure on construction operations exceeds £1m over a three-year period. This typically catches businesses with a significant construction spend, such as large retailers and public bodies.
The domestic reverse charge will have a significant impact on cashflow management for the sub-contracting businesses involved, particularly the smaller sub-contractors. Many of them have historically relied on VAT to cover their short term cash flow needs.
This could push those small sub-contractors over the edge, and we may see many of them disappear in the months after the reverse charge is ultimately introduced.
Prior to announcing the year delay, HMRC had acknowledged the difficulties of implementing the new rules and had promised a light touch in dealing with any errors that occur in the first six months.
How to prepare for reverse charge VAT
Businesses classed as main contractors will need to ensure they do not pay over the VAT element to the supplier, as they’ll still be liable to account for the VAT to HMRC.
Such firms will have to account for the reverse charge VAT on their own VAT return. They’ll be able to recover the reverse charge VAT incurred on the same VAT return, subject to the normal VAT rules.
Works covered by CIS
Services covered by the reverse charge are those falling within the definition of ‘construction operations’ in CIS, which GOV.UK lists as the following activities:
- a permanent or temporary building or structure
- civil engineering work like roads and bridges
- preparing a site, e.g. laying foundations and providing access works
- demolition and dismantling
- building work
- alterations, repairs and decorating
- installing systems for heating, lighting, power, water and ventilation
- cleaning the inside of buildings after construction work.
There are supplies that are excluded from the reverse charge. For example:
- professional work of surveyors, architects or consultants in the building
- machinery and the delivery of the machinery to the site
- drilling for the extraction of natural gas or oil
- installation of security systems which include closed-circuit television and burglar alarms.
The CIS scheme will shake-up the way payments are made in construction. Smaller firms may feel the pinch as they will no longer be able to use VAT monies to bolster their cash flow.
With a year until the scheme will be introduced there is time to review impacts and arrange extra credit where necessary.
Read more on tax as part of our #AATPowerUp Tax 2020 campaign for September and October:
- Power up your tax knowledge with AAT
- How MTD for income tax will shape the digital landscape
- How green taxes will shake up life in the UK
- 5 ways HMRC could plug the tax gap
Image source: Heye Jensen via Unsplash.
Brian Palmer is the tax policy adviser for AAT.