On March 1st 2021, HMRC will be introducing the new VAT Reverse Charge. This will affect all businesses that operate within scope of CIS (Construction Industry Scheme) – namely those who sub-contract to other businesses.
VAT registered business are normally required to charge VAT to their customers and then pay that VAT over to HMRC. The customer, if VAT registered would typically recover the VAT in their own VAT return.
HMRC have identified that the construction and building industry has a higher than normal occurrence of traders who are charging VAT but failing to make the relevant declarations and payments to HMRC. This has a knock on effect for the customers who are sometimes unable to legitimately recover the input VAT as well as an effect of reducing the collectability of these taxes.
From 1st March 2021, some VAT registered building and construction services will become subject to the ‘Reverse Charging’ rules. Those rules mean that the supplier does not raise a charge for the VAT element of their invoices. However the customer has to recognise the VAT element and reflect this as output VAT in their own VAT return, whilst at the same time recovering the input VAT that would have been charged by the supplier. The net effect is that the customer has essentially collected the VAT from the supplier on behalf of HMRC.
Are there any criteria for this to apply?
The new rules will only apply to activities that would normally be subject to the Construction Industry Scheme (CIS). The services that would be covered include general building and construction work including renovations, maintenance services, heating and air conditioning, painting and decorating and cleaning services where part of a construction project. Standard rated (20%) and reduced rated supplies (5%) are both affected but zero rated supplies are not.
Professional services are not covered by this legislation and neither are supplies of security systems or burglar alarms.
If there is a combination of services supplied, where some will qualify and others don’t, the expectation is that the whole charge will be accounted for using the reverse charge mechanism.
Note that these changes only affect businesses that are part of the supply chain and this does not affect the charges raised to the end customer by the main contractor.
What to put on the supplier’s invoice
In addition to the standard information required on a VAT invoice as per the 1995 VAT Regulations, the supplier of a specified service must also include:
· A note to show that the domestic reverse charge applies to the invoice and that the customer must account for the VAT. The 1995 VAT Regulations state that the words “reverse charge” must be used.
· The amount of VAT due under the reverse charge. If it is not possible to show the amount of VAT due, the rate of VAT must be shown. This is shown as a note; the VAT should not be included in the amount charged to the customer. Some examples of invoice wording that meets the legal requirement are – reverse charge: VAT Act 1994 Section 55A applies/reverse charge: S55A VATA 94 applies/reverse charge: Customer to pay the VAT to HMRC.
How does this affect the VAT return
When completing the VAT return the supplier will need to show the turnover in box 6 but not show any output VAT in boxes 1 and 3. The net effect is that no VAT is due on that sales invoice.
The customer, upon receipt of the reverse charge invoice will present this in his VAT return as normal but with a dummy entry for the implied input VAT in box 4. There will also be a dummy entry for Output Vat in boxes 1 and 3 but no corresponding entry in Box 6.
The net effect on the customer is that no VAT is recovered from the supplier’s invoice as none was paid to HMR&C in the 1st place.
What are the practical implications?
Aside from the obvious complexities when preparing invoices, businesses will need to ensure that accounting software is properly programmed to address these changes. It is our understanding that most software companies are working on upgrades to accommodate this for their customers.
Subcontractors who work primarily for larger contractors within the building industry may find that all of their subsequent VAT returns will produce a refund position. In such circumstances, the sub-contractor may wish to consider moving to monthly VAT returns to accelerate the inward cash-flow. The fact that subcontractors will also not be receiving VAT from their customers may also mean that inward cashflow is compromised, especially in the transition period.
What next?
It is imperative that any business that expects to be affected by these changes liaises with their tax advisor. The legislation is quite complex and the above only covers the main criteria so further research is recommended to ensure the approach is tailored to each business scenario. HMRC appreciate that this is a substantial change for many businesses and have suggested they will adopt a ‘light touch’ approach to the 1st couple of VAT returns following these changes, but only where it can be seen that the tax payer is trying to comply with the legislation.
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