The domestic reverse charge is being introduced from 1 March 2021 as a move to counter VAT evasion. It was originally intended that the charge would come into effect from 1 October 2019, but this was deferred until 1 October 2020 to enable affected businesses to better prepare. It was then deferred again for five more months as a direct result of the COVID-19 pandemic.
The domestic reverse charge will bring about a significant change to the way in which businesses in the construction industry account for VAT. Affected businesses should ensure that they are familiar with the new rules and take practical steps to ensure that their accounting systems can deal with the changes. Where the new reverse charge applies, the customer receiving the services will be obliged to account for VAT due rather than the supplier.
Application
The domestic reverse charge will apply to the following types of services:
- constructing, altering, repairing, extending, demolishing or dismantling buildings or structures;
- constructing, altering, repairing, extending, demolishing any works forming, or planned to form, part of the land;
- installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure;
- internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration;
- painting or decorating the inside or the external surfaces of any building or structure;
- services which form an integral part of, or are part of the preparation or completion of the services described above
VAT registered businesses must use the reverse charge when supplying building and construction industry services in situations where:
- the customer is registered for VAT in the UK
- payment for the supply is reported within the Construction Industry Scheme
- the services supplied are standard or reduced rated
- it is not an employment business supplying staff or workers
- the customer has not given written confirmation that it is an end user or intermediary supplier
For those VAT registered businesses buying building and construction industry serviced, the domestic reverse charge must be used in situations where:-
- payment for the supply is reported within the Construction Industry Scheme
- the supply is standard or reduced rated
- the supply does not involve the hiring of staff or workers
- the customer is not using end user or intermediary exclusions
End users and intermediaries
An end user is a business that is registered for VAT and CIS but does not make onward supplies of the building and construction services supplied to them. The domestic reverse charge will not apply to supplies to end users where the end user tells its supplier or building contractor in writing that it is an end user.
An intermediary supplier is one that is registered for VAT and CIS and is connected to an end user. The domestic reverse charge will not apply in situations where an intermediary supplier buys construction services for onward supply to a connected or linked end user without making material changes, the intermediary will be treated as an end user.
To be connected or linked to an end user, intermediary suppliers must either:
- have a relevant interest in the same land where the construction works are taking place; or
- be part of the same corporate group or undertaking
The domestic reverse charge will not apply to supplies to intermediary suppliers where the intermediary supplier notifies its supplier or building contractor in writing that it is an intermediary supplier.
Invoicing and VAT returns
The following sets out the current and future invoicing and VAT return reporting position in a simple scenario involving a sub-contractor supplying heating installation services priced at £10k (excluding VAT) to a main contractor working on a £2m (excluding VAT) construction project for its end user client.
The sub-contractor would currently charge VAT – it would issue an invoice to the main contractor for £10,000 + £2,000 VAT. The sub-contractor would declare the £2,000 output tax to HMRC in box 1 of its VAT return. The main contractor would recover £2,000 input tax from HMRC via box 4 of its VAT return.
In the new regime, the sub-contractor will issue an invoice to the main contractor for £10,000 + £0 VAT and include wording on the invoice making it clear that the Domestic Reverse Charge applies, and that the customer is responsible for accounting for the VAT. The £2,000 VAT that the customer needs to report should be shown somewhere on the invoice, but not as total VAT charged in addition to the net amount. The sub-contractor would not declare any VAT on its VAT return. Instead the main contractor would report £2,000 output tax in box 1 and £2,000 input tax in box 4 on its VAT return.
So overall, the net financial effect is entirely neutral.
Both currently and in the new regime, the sub-contractor would include the £10,000 VAT exclusive amount in box 6 (net outputs) on its VAT return and the main contractor would include the £10,000 in box 7 (net inputs) on its VAT return.
As for the treatment of the supplies made by the main contractor to the ultimate client, the current position would see the main contractor issue periodic invoices totalling £2m + £400k VAT. It would declare £400k output tax to HMRC via its VAT returns and the client would recover whatever entitled to via box 4 of its VAT returns. There would be no change in the new regime provided the client makes the main contractor aware in writing that it is the end user. Otherwise, the main contractor should work on the basis that the domestic reverse charge applies and invoice accordingly.
Businesses who are applying the domestic reverse charge regularly may find that they become repayment traders i.e. they are regularly reporting a net repayment position on their VAT returns. Such businesses may wish to consider switching to monthly VAT returns to improve their cash flow.
If you would like to know more about this issue or have another VAT issue you would like to discuss, please contact our VAT department (vat@pem.co.uk) or your usual PEM adviser.
