VAT Reverse Charge: Managing the Change
Introduced earlier this year, the reverse charge means that in much of construction, service suppliers no longer collect VAT. Instead, responsibility for VAT accounting shifts to main contractors.
Especially for subcontractors, the new rules represent a massive change, both in terms of invoicing and cash flow management. Here’s a look at how small businesses can absorb this change…
Reverse charge in brief
The new rule came into force on 1 March 2021 and applies to businesses that are part of the Construction Industry Scheme (CIS), either as contractors or subcontractors.
Instead, suppliers indicate on the invoice that the VAT needs to be dealt with by the customer. The customer accounts for the VAT as an input tax (as if they’ve made the supply to themselves).
How it works: an example
Joiner Joe carries out work for Builder Ltd, a CIS and VAT-registered company. The value of the work is £10,000 plus VAT at 20%.
Joe invoices Builder Ltd for £10,000 with no VAT. However he must include a note on the invoice indicating that the customer must deal with the VAT (e.g. “Reverse charge applicable: customer to pay the VAT to HMRC”). He must also indicate either the amount that the customer needs to declare as the reverse charge (£2,000 in this case), or at least stipulate the rate to be applied for the item in question (i.e. 20%).
Builder Ltd includes the £2,000 as an output tax on its VAT return (Box 1). Assuming that no exemptions or non-business apportionments apply, the company includes the same amount as input tax in Box 4 of the return. By the way, we are construction accountants and can help with VAT returns.
Does the VAT reverse charge apply? Matters to check
As a supplier of services, if you don’t charge VAT when you should have done, you will be required to pay the output tax on the sale. If you incorrectly charge VAT when the reverse charge should have been applied, the customer will be assessed for the output tax which will offset any entitlement to input tax recovery.
For each customer, suppliers need to do the following checks as a matter of course:
If the customer is not CIS registered, then normal VAT accounting applies, and the reverse charge can be disregarded.
VAT status can be verified via HMRC’s VAT number checker service. Again, for non-registered customers, the reverse charge does not apply.
The categories of work covered by the construction VAT reverse charge is based on the definition of ‘construction operations’ under the CIS. If you are unsure whether services provided are covered, refer to the HMRC CIS guidance.
In most cases this will be 20%. However, the reduced rate of 5% may apply in certain circumstances (e.g. converting a commercial property into residential). Zero-rated services (e.g. construction work on new residential dwellings) are excluded from the reverse charge rules.
Check for customer-as-end-user and intermediary supplier exemption
The reverse charge only applies where your customer makes an onward supply of construction services to their own customer. Therefore, for example, it wouldn’t apply if you were contracted to carry out work on your customer’s headquarters. If your customer is connected or linked to the end user (e.g. a landlord and tenant arrangement), the customer is classed as an ‘intermediary supplier’. Again, under these circumstances, the normal VAT rules apply instead of the reverse charge.
Instead of leaving it in the business account until the next VAT return is due, it’s common for subcontractors to use VAT paid by customers to settle suppliers’ bills and cover various other commitments. With so many payments now being received net of VAT, that temporary cash flow buffer is no longer there.
If you are already feeling the heat as a result of no longer having as much cash flowing into the business, now is the time to take action. One option might be to alter how the business is funded in the short-term so that your cash flow profile has the chance to catch up with the new way of working. Refinancing may be a possible way forward: e.g. re-organising costly loans or leasing arrangements to reduce outgoings.
A fresh pair of eyes here can be invaluable. A chat with our business consulting team can be just what’s needed to uncover possible funding and restructuring opportunities and weigh up your options.
To determine whether the reverse charge applies, you are required to ascertain the status of each new customer. You will also need to keep contracts under constant review, particularly when it comes to determining whether a customer has ‘end user’ status. Where relevant, invoices will need to contain the notice that your customer is required to account for the VAT to HMRC.
It’s a lot to keep track of, especially if you are still grappling with basic templates and manual input for invoicing.
Leading accounting tools such as Xero and Sage have updates in place to reflect the change. These ensure that the correct rates are applied and that invoices are populated automatically with a reverse charge notification where relevant. Such systems are also useful for keeping track of customer information, including information linked to VAT status.
To ensure ongoing compliance with the change, this could be the ideal opportunity to move away from outdated systems. For unbiased advice on choosing the best accounting software for your business, as well as help with implementation, migration and training, speak to us today
If you are still confused, or would like any more information, please get in touch with us and one of our fully qualified accountants will be able to help.