written by Ruth Corkin, VAT specialist and indirect tax advisor
HMRC is conducting a technical consultation on draft legislation for a VAT reverse charge on certain construction services. The final version of the legislation is likely to be published in October 2018 but will only come into effect on the 1st of October 2019 (*update now delayed until March 2021). Will your business be affected?
In this article we will look at:
- A quick recap of normal VAT accounting and reporting.
- What is the VAT reverse charge for construction services and how is it different from normal VAT accounting and reporting?
- Which construction services will be impacted by the VAT reverse charge?
- Why is HMRC bringing in a VAT reverse charge for construction services?
- Likely impact of the VAT reverse charge on relevant construction businesses.
- Additional remarks.
- Where can I get more information?
A quick recap of normal VAT accounting and reporting.
Put simply, VAT, or Value Added Tax, is levied on qualifying goods and services. You will charge VAT on the goods or services that you sell to customers (output VAT) and you pay VAT on goods and services that you buy from other businesses (input VAT).
The output VAT you charge on invoices has to be paid over to HMRC but you can also claim the input VAT that you paid on supplier invoices. On your VAT return, you will do a reconciliation between the two and only pay over the balance, that is total output VAT minus total input VAT. If you’ve paid more input VAT than charged output VAT you claim the balance from HMRC.
This just a very basic explanation on the principle of VAT. The actual calculation can get much more complicated if you take into account the different rates, including zero-rated and exempt supplies, and the different adoption and reporting methods (i.e. annual accounting scheme, cash accounting scheme, flat rate scheme, etc.), but that is beyond the scope of this article.
If you interested in getting a deeper understanding of VAT and all its complexities, HMRC has a detailed VAT section on their website.
What is the VAT reverse charge for construction services and how is it different from normal VAT accounting and reporting?
With a VAT reverse charge, VAT is accounted for and reported by the customer, rather than the supplier. This paragraph from HMRC’s tax information note perfectly sums up the difference: “The introduction of a reverse charge does not change the liability of the supply of the specified services. What does change is the way in which the VAT on those supplies is accounted for. Rather than the supplier charging and accounting for the VAT, the recipient of those supplies accounts for the VAT.”
Normally a supplier will account for VAT charged on their supplies and report it to HMRC. However, with the proposed VAT reverse charge policy, this burden will shift to the customer and they will have to account for VAT on the supply of any goods and services that they have purchased.
“Where a VAT-registered business receives a supply of specified services (which are not excepted supplies) from another VAT-registered business on or after 1 October 2019, it accounts for that VAT amount through its VAT return instead of paying the VAT amount to its supplier. It will be able to reclaim that VAT amount as input tax, subject to the normal rules. The supplier will need to issue a VAT invoice that indicates the supplies are subject to the reverse charge.”
Therefore, businesses providing certain types of construction services (see below) to another business in the construction industry will not charge VAT. Instead, the recipient business will need to account for a reverse charge on its VAT return.
Which construction services will be impacted by the VAT reverse charge?
In the draft legislation, HMRC has identified and defined the construction services that will be impacted by the VAT reverse charge, including:
(a) construction, alteration, repair, extension, demolition or dismantling of buildings or structures (whether permanent or not), including offshore installations;
(b) construction, alteration, repair, extension or demolition of any works forming, or to form, part of the land, including (in particular) walls, roadworks, power-lines, electronic communications apparatus, aircraft runways, docks and harbours, railways, inland waterways, pipe-lines, reservoirs, water-mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence;
(c) installation in any building or structure of systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection;
(d) internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration;
(e) painting or decorating the internal or external surfaces of any building or structure;
(f) services which form an integral part of, or are preparatory to, or are for rendering complete, the services described in paragraphs (a) to (e), including site clearance, earthmoving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works.
Businesses that only undertake work for consumers, construction companies that will not onward supply your services, supplies between landlords and tenants or connected parties will not be affected by the VAT reverse charge. However, if you are a contractor doing work for larger construction contractors, the reverse charge may apply, depending on where you are in the chain. In the same breath, if you are the main contractor using smaller sub-contractors, you will need to know how the reverse charge works.
The document identifies further construction services that are not to be included under the definition, as well as supplies that might fall under the definition but are specifically exempt from the legislation.
Why is HMRC bringing in a VAT reverse charge for construction services?
The VAT reverse charge is being implemented as an anti-fraud measure, specifically to remove the opportunity for ‘missing trader fraud’ within the supply of certain construction services.
According to Europol, missing trader fraud costs revenue authorities across the EU around €60bn annually in tax losses.
So what is missing trader fraud?
A supplier might charge VAT on their invoices and then ‘disappear’ before they pay the output tax over to HMRC. Construction services have become especially lucrative for fraudsters because of the insignificant VAT costs on labour-only supplies within the industry (wages are not subject to VAT), however, they are still able to charge VAT to customers, giving them the incentive to go missing and effectively keep the VAT for themselves.
This HMRC consultation document goes into detail on how VAT fraudsters are targeting the construction industry and what the proposed responses are to combatting this.
A reverse charge on VAT makes it impossible to commit missing trader fraud exactly because the customer, rather than the supplier, accounts for the VAT directly to HMRC.
It is interesting to note that the construction industry will not be the first sector to attract a reverse charge on VAT. Other industries include:
- Mobile telephones and computer chips – effective 1 June 2007
- Emissions allowances – effective 1 November 2010
- Wholesale supplies of gas and electricity – effective 1 July 2014
- Wholesale supplies of certain electronic and telecommunications services – effective 1 February 2016.
Likely impact of the VAT reverse charge on relevant construction businesses.
According to the Autumn Budget 2017, the policy will have a positive impact on revenue from tax collections for the government, enabling them to collect VAT due of £400+ million in the first 5 years of implementation.
Although the policy will have no direct impact on individuals, families or households, it will have a significant impact on relevant businesses in the construction sector. HMRC estimates that between 100,000 and 150,000 companies will be affected and will most likely incur extra costs in the following areas:
- Costs for familiarisation with the new rules.
- Adapting VAT accounting systems and processes to enable reverse charge supplies to be calculated and reported.
- Keeping records of all reverse charge supplies.
- Checking purchases are correctly treated.
- Additional time spent on VAT returns.
Ireland has operated a similar reverse charge for a number of years but the scope of activities deemed to be “construction activities” for the purposes of the policy are much broader. The Irish system is linked to the definitions for Relevant Contracts Tax (RCT), which is similar to the UK’s Construction Industry Scheme (CIS).
Activities covered under the VAT reverse charge for construction services are wider than those covered under the CIS, so there is a danger that contractors will not read what activities fall under the VAT reverse charge policy, which could lead to non-compliance and penalties.
UK established recipients of construction services are also already caught by a reverse charge, if they use a sub-contractor that is not established in the UK. This has been enshrined in the UK VAT law for some years, but HMRC is only just starting to enforce or use it.
Where can I get more information?
HMRC’s website is a wealth of information. The documents below are particularly useful (NOTE – these are draft documents and information contained in them are subject to change up until the final legislation is published in October 2018):