Tax accounting - domestic reverse charge VAT for construction services

The aim of this measure is to remove the opportunity for missing trader fraud within the construction industry. Under the new regime, a VAT registered business, which supplies certain construction services to another VAT registered business for onward sale, will be required to issue a VAT invoice stating that the service is subject to the domestic reverse charge. The reverse charge will also apply to goods supplied with specified services.

The buyer will be responsible for bringing VAT to account rather than the supplier. This prevents the supplier from charging what purports to be VAT to the customer, but then absconding with the VAT element and not paying it over to HMRC. For VAT purposes, suppliers of goods or services under the domestic reverse charge must not enter in box 1 of the VAT return any output tax on sales to which the domestic reverse charge applies, but must enter the value of such sales in box 6. Customers must enter in box 1 of the VAT return the output tax on purchases to which the domestic reverse charge applies, but must not enter the value of such purchases in box 6. They may reclaim the input tax on their domestic reverse charge purchases in box 4 of the VAT return and include the value of the purchases in box 7, in the normal way.

Essentially construction industry firms will be required to charge themselves VAT when they buy construction related services from other firms, referred to as a 'reverse charge'.

Example:

Subcontractor A undertakes groundwork services for contractor B. 

Currently subcontractor A charges VAT at the appropriate rate on the invoice it issues to contractor B, B pays the VAT to A and A pays it to HMRC.

From 1 October 2019 under the reverse charge rules, subcontractor A issues an invoice to contractor B stating that its services are subject to a reverse charge, so subcontractor A does not charge VAT. Contractor B adds VAT to the cost of the work undertaken by subcontractor A and includes this as output tax within its own VAT records. Contractor B claims the same amount of VAT on the same return as input tax, meaning there is no net payment due to HMRC.

This new reverse charge will not apply if contractor B is the 'end user' who will sell the newly completed build to the final customer. It also does not apply for transactions between connected companies (e.g. within a group of commonly owned businesses) or where the supplier and customer are landlord and tenant. If the services concerned would be zero rated for VAT purposes, the reverse charge is not relevant.

To prepare for the reverse charge, checks should be carried out to confirm whether the customer is VAT registered, record their VAT registration number, their CIS status and also whether the customer would be an 'end user' in the supply chain.

Construction businesses will need to ensure their tax accounting systems are capable of processing reverse charge supplies and make ongoing checks to ensure that supplies and purchases are correctly treated. As the VAT amount must still be shown on invoices subject to the domestic reverse charge, the risk that suppliers will account for the VAT to HMRC in error and customers will recover it from HMRC is clear. Invoices for domestic reverse charge supplies, when the customer is liable for VAT, must include the reference 'reverse charge' – 'Reverse charge: Customer to pay the VAT to HMRC' is an acceptable legal requirement.

Subcontractors that rely on VAT collected from their customers as working capital until they have to remit it to HMRC are likely to suffer from the loss of cash flow. These businesses may have to consider if payment terms need to be revisited to avoid problems in the supply chain.

Click here for a flowchart relating to the VAT reverse charge.

If you require further information on VAT reverse charging or on any tax accounting issues

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