VAT Domestic Reverse Charge Explained
The VAT domestic reverse charge is solely for the building and construction services. This charge is essentially just an extension of the already known construction industry scheme (CIS). The DRC is simply a change on how VAT is handled in regards to building materials used directly in their services.
This doesn’t apply to materials that are supplied separately from the construction service. This reverse charge will be introduced without a transitional period and will no doubt have a high impact on your businesses cash flow – providing you are in the construction sector.
Over the years HMRC has noticed a high number of cases regarding fraud in the building industry. The most common of those being missing trader fraud, this, however, is not HMRC’s first try to prevent the trader fraud, they have just been unsuccessful with their efforts so far.
HMRC is cracking down on this particular case of fraud as it is estimated that at least £100 million per year is lost by the situation. As a result of this, the revenue is introducing a charge very similar to the previously seen domestic reverse charge for the sale of mobile phones and computers.
In essence, HMRC has decided that the way to combat this common fraud is to remove the option to collect and charge VAT. Resulting in nothing to actually defraud.
Going forward the newly introduced charge will mean that those supplying construction and building services to VAT-registered customers will no longer have to account for the VAT.
The customer will now have to account for this VAT (which will be considered input tax). Suppliers will need to check if their customer is VAT registered before proceeding. With DRC, the end user always pays the VAT, however, this may not always be obvious to contractors of who the end-user is.
Which could result in an unexpected cost to this end-user. On the odd occasion nonetheless, this will be more than obvious. Even if the customer has not given confirmation that it is the end-user, HMRC state that VAT should be charged in the normal way regardless.
If your customer does confirm they are the end-user, it would also be ideal for you to confirm their VAT and CIS state along with the required VAT number.
What services does the VAT reverse charge apply to?
If you are unsure what services this new legislation applies to, here are a few examples:
- Construction Repair
- Power Supply
- Ventilation/Air Conditioning
- Heating Systems
As well as a list of services under the new legislation, there are also a number of services that will be excluded from this charge.
You can find a more detailed breakdown of the services that DRC applies & does not apply to on HMRC.
How will this affect business in the construction industry?
From reading the short text above I’m sure you have grasped that this will have a significant impact on your business in the construction industry.
HMRC also acknowledges this fact and realizes business must first adapt their accounting systems to process these supplies.
As mentioned above, this will also have an impact on your businesses cash flow which may suffer a loss.
In other words, you will no longer be able to use the VAT you collect from customers as working capital before it is paid over to HMRC.
When is the VAT reverse charge introduced?
The VAT domestic reverse charge for the construction industry will come into effect from 01st October 2019.
What does the VAT reverse charge mean for a subcontractor?
This will no doubt also affect your cash flow, but other than the obvious, the VAT reverse charge should mean very little to you, if you are a subcontractor. The VAT charge will be passed on when you issue your VAT invoice and no other action is required.
In regards to a subcontractors cash flow, you will no longer be paying VAT on your sales and therefore likely become what the revenue refers to as a repayment trader. To improve your cash flow in these circumstances HMRC recommends you switch to monthly returns to speed up repayments.
Remember that timing is important, and you will need to switch at the correct month to avoid an irregular VAT period.
What do I need to do with my invoices?
It should be clear on all of your invoices that the reverse charge has been applied. Make sure you use the correct terminology to indicate this. According to HMRC, your terminology can be any of the following,
- Reverse charge: VAT Act 1994 Section 55A applies
- Reverse charge: S55A VATA 94 applies
- Reverse charge: Customer to pay the VAT to HMRC
We are unsure what accountancy software will account for these changes so make sure to look out for any updates to help with the new legislation.
Does the VAT reverse charge affect the flat rate scheme?
You will be glad to know that reverse charge supplies are excluded from the flat rate scheme and so should be accounted for in the usual way. The turnover, however, will be reduced on the basis of claiming VAT, so it is a good idea to seek professional advice from your friendly neighbourhood accountant.
What actions should I take?
The date of effect is approaching fast and there isn’t long left to prepare. First things first, construction businesses should review any supplies that are made and received from other VAT registered contractors to establish an idea of where the VAT reverse charge will apply.
As mentioned, we are unsure what accountancy software will relay the changes in new updates, so be sure to look out for and consider any requirements and changes you need to make to prepare for the reverse charges.
Try to obtain confirmation from your customers to ensure whether they are the end-user or not. Also, ask for confirmation of their VAT and CIS status. Consider what we have discussed regarding cash flow and speak to a professional on how to improve this.
What do I do if I am unsure this applies to my business?
Numerous accounting bodies, including HMRC themselves, have published information on the upcoming changes, which you can find from a simple Google search. You can view more information from the revenue here.
Even though there is no transitional period for the approaching reverse charges, HMRC has stated they will apply a “light touch” to any mistakes made by businesses in the first 6 months. But, don’t mistake this for a chance to ignore DRC altogether, as you will be fined indefinitely.
The single most important step to take if you are unsure about this is to contact your financial professionals.