VAT reverse charge for construction services

A VAT reverse charge for construction services will potentially apply to supplies of construction work from 1 March 2021. The original intention was to introduce these measures from October 2019. However they have been delayed twice due to Brexit and the COVID19 pandemic.

VAT reverse charge for construction services

The aim of these rules is to reduce VAT fraud in the construction industry services sector. 

When does the VAT reverse charge for construction services apply?

The proposed changes apply to sales of construction work and when all of the following conditions are met:

  • There is a supply for VAT of construction services and materials
  • The supply is made at the standard or reduced-rate of VAT
  • The supply is made between a UK VAT registered supplier and UK VAT registered customer
  • Both supplier and customer are registered for the Construction Industry Scheme
  • The customer intends to make an ongoing supply of construction services to another party
  • The supplier and customer are not connected

Supplies not caught by the VAT reverse charge

The VAT reverse charge does not apply to any of the following supplies:

  • Supplies of VAT exempt building and construction services
  • Supplies that are not covered by the Construction Industry Scheme unless linked to such a  supply
  • Supplies of staff or workers
  • Supplies of materials only

The VAT reverse charge does not apply to taxable supplies made to non-VAT registered customers, VAT registered customers who are not intending to make further on-going supplies of construction and Intermediary customers who are connected.

What activities are caught by the VAT reverse charge for construction services? 

HM Revenue have issued comprehensive guidance as to those services within the scope of the new rules. For example Installing heating, lighting or air-conditioning in a building is within the scope of the new rules, whereas installing security systems and carpet fitting is not. 

Certain services will potentially fall within the scope of the new rules especially where there is reverse charge element. If that's the case, then the whole supply will be subject to the reverse charge. 

For example, a joiner constructing a staircase offsite then installing it onsite is making a reverse charge service due to the installation element of the supply. 

An example

Jack  (who is VAT registered) supplies the materials and installs a new air conditioning system for James a contractor (who is also VAT registered) who in turn supplies his construction services to Juliet the developer (also VAT registered). Juliet finds and develops land and will, in this case, bring the build to completion and supply a finished commercial building to Dharma Ltd, her client.

Jack would under the current VAT system, invoice James £120,000, comprising of his £100,000 bill for materials, labour and works, plus £20,000 in VAT (at 20%).

From March 2021, under the new reverse charge mechanism, Jack invoices £100,000 stating that 'the reverse charge applies'.

Jack pays James the net £100,000 fee James then accounts for output and input VAT of £20,000 on the supply on his  own VAT return. Jack does not account for output VAT in his accounting system as he has invoiced only his fee £100,000.

As a result of the reverse charge procedure, Jack charges and receives £20,000 less than under the old system (where he would charge £100,000 + VAT). He does not have to account to HM Revenue for any VAT on his services.

These changes might have a negative impact on Jack’s cash flow, as previously if James paid promptly Jack could use the VAT of £20,000 to purchase his materials. The VAT on these materials  could be offset against the VAT on his sale.

James has a cash flow advantage, as he does not have to pay Jack £20,000 and then at the end of his VAT quarter reclaim £20,000 as he is accounting for the reverse charge and the output VAT offsets the input VAT.

As James is supplying construction services he must also consider the reverse charge if Juliet is involved in the onward supply of construction services to her client it will be her responsibility to notify the other parties in the chain.

Other VAT implications

The Cash Accounting Scheme cannot be used for supplies that are not within the reverse charge. If you use cash accounting for your purchases Cash Accounting Scheme no longer helps your cash flow. In that case it may be better to cease Cash Accounting.

Supplies that the reverse charge applies to are excluded from the Flat Rate Scheme. Any such supplies had and made should be accounted for under the reverse charge provisions.

If a business is likely to become a VAT repayable business it will be beneficial for it to move to monthly VAT returns.

Cash flow permitting, annual accounting can be used with reverse charge supplies being accounted for within the scheme

The VAT reverse charge  for construction services will require businesses operating in this sector to change their approach significantly. Accounting and bookkeeping systems in particular will need to be modified to cope with the new invoicing and reporting obligations.

For more useful information, check out our Ebooks here.

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