Which businesses will it impact?
Individuals or Businesses in the building and construction industry who are VAT registered and registered under (or should be registered under) CIS will be impacted. Businesses who are under "Gross Status" for CIS will also fall under the new reverse charge rules.
Businesses classed within the buildings and construction industry may include:
Professional services of architects, surveyors, valuers, estate agents, interior or exterior design consultants and solicitors are NOT subject to the reverse charge rules.
What is the reverse charge system and how will it be different?
Up to now and up to the 28th February 2021, VAT registered businesses in the building and construction industry have applied VAT on their services and purchases in the same way as most other industries. In short, when a business purchases a good or services from other VAT registered businesses, they are charged VAT which can be reclaimed through their own VAT returns. When they make a sale for their goods or services to their customers, they have to charge the appropriate rate of VAT on their invoice. Their customer will pay the invoice at the gross amount (inclusive of VAT) and the business will declare the VAT to HMRC via their VAT returns and pay it over.
Under the new reverse charge system, the contractors involved in the chain of construction would only charge VAT if their customer is the “end user” of the goods or service. Any contractors acting as sub-contractors who are not supplying their services or goods to the “end user” will no longer charge VAT. Instead, they will issue an invoice for their services and goods without VAT and include a note on their invoice that “CIS reverse charge applies”.
Laura owns an old house and wants to renovate it so she can live in it.
Bob is a VAT registered builder who Laura has contracted to renovate the house.
Paul is a VAT registered roofer who Bob has sub-contracted to complete the roofing on the house.
Paul completes the roofing and raises an invoice to Bob for £20k. Since Paul is sub-contracted by Bob and not by Laura (who is the end user), the reverse charge rule will apply. Paul will therefore NOT charge any VAT to Bob. Instead, Paul’s invoice will include a note that “CIS reverse charge applies”.
Bob will pay Paul just the £20k. No VAT has been charged at this stage. Any VAT that Paul has incurred on materials he has purchased from builders’ merchants, he will be able to reclaim through his VAT return in the usual way.
Bob will then invoice Laura for his work on the completed house. But since Laura is the end user, Bob WILL need to charge VAT at the applicable rate for the work. Laura will pay Bob for the VAT inclusive amount.
How do the VAT returns work?
Following on from the example above, Paul will not include any VAT in his VAT return box 1 relating to his sales invoice since he did not charge VAT. His sale of £20k will be reported in box 6 of his VAT return at £20k.
Bob will not record any VAT in box 4 of his VAT return since he has not been charged any VAT by Paul. When Bob raises his sales invoice to Laura, which will include VAT, he will record the sales VAT in box 1 of his VAT return in the usual way.
How to determine the “end user” and what are their responsibilities?
The end user is the person or business who owns or benefits from the use of the building or structure being constructed.
It is obvious to identify who the end user is if the construction relates to a domestic structure such as a house. However, if the structure is an office building or a publicly used development such as a road or a leisure centre, then you will need to find out who will ultimately own the structure before deciding if you should charge VAT or apply the reverse charge. Remember that you will only charge VAT if you are invoicing the end user for your services. Or if you are an ‘intermediary supplier’ and are connected to the end user. See the following link for more guidance. https://www.gov.uk/guidance/vat-reverse-charge-technical-guide#when-to-check-if-your-customer-is-vat-and-construction-industry-scheme-registered-or-an-end-user
If the end user is a domestic customer or private non-VAT registered individual, then there is no obligation to obtain written confirmation of this fact from them. However, if the end user is a business or public entity or VAT registered entity then you may need written confirmation from them before charging VAT. See also the link above.
Who will this affect and how?
Cashflow – For sub-contractors who are now required to apply the reverse charge, since they are not charging Vat on their invoice, they are not receiving the VAT inclusive cash from their customer either. If their customer had previously been a prompt payer, it is likely that the sub-contactor would have received the VAT inclusive settlement of their invoice before they had to pay the VAT over to HMRC and would benefit from a cashflow advantage. Under the reverse charge rule, less cash will be received from customers. Although less cash will be required for payment to HMRC following a VAT return declaration either.
Record keeping – As well as the potential requirement to obtain confirmation of who end users are as detailed in the link above, under reverse charge operations the seller will need to ensure that they include the reverse charge paragraph on their sales invoices. If your sales invoices are produced using an accounting software, you will need to ensure that your software will be programmed to deal with the changes.
Software updates – Will your software be ready to deal with the invoice narrative changes and correct application of VAT on your invoices? Will your software be able to recognise what VAT amounts should be included in your VAT returns? We advise that you consult with your software provided and discuss how they plan to deal with the changes. You may need to upgrade or update your software. You may require training from your software provider.
We have provided a summary of the basic changes coming into place. Some businesses will require further guidance since complications may arise such as construction contracts which stagger over the 1st March when the changes come into place. Or contracts which include supplies which are exempt from VAT or partially exempt. And in some cases where you may sell the manufacturing of goods (which is not subject to the reverse charge) but also the installation of the goods (which may be subject to the reverse charge).
You can also download the Xero Guide to Domestic Reverse Charge VAT for Construction
If you have any questions or we can help you with any COVID-19 or other business support queries, please get in touch. Email the team firstname.lastname@example.org or call 01858 289 189. You can also refer to our COVID-19 support page.
Thanks for stopping by,
Charlotte & The Business Hut Team