The reverse VAT charge – what you need to know
It's been some time since our last update on VAT "reverse charging" for the construction sector. Originally due to come into force on 1 October 2019, the impact of the COVID-19 pandemic understandably brought about a postponement of the Government's plans. A delay of 17 months in total brought us to its recent implementation on 1 March 2021.
Put simply, under the new reverse charge system, VAT is paid direct to HMRC instead of being paid to the supplier of the VATable services. The principal reason for this change is that HMRC is seeking to tackle VAT fraud, whereby suppliers of services charge and receive payment for VAT but do not send these monies on to HMRC. The UK Exchequer has estimated its losses in this regard as being circa £100million per annum.
Does the reverse charge apply to your services?
The reverse VAT charge became mandatory on 1 March 2021 and now applies to building and construction services which meet all of the following criteria, regardless of when the contract for the services began or when the work was carried out:
- The supply falls within the scope of the Construction Industry Scheme (CIS); and
- The supply is standard rated or reduced rated; and
- The customer receiving the supply is VAT registered; and
- The customer is registered for CIS; and
- The customer has not confirmed that it is an 'end user' (see 'Who is an end user?' below)
The reverse charge system will not apply:
- to zero-rated supplies of goods and services – as such, it will not apply to the construction of dwellings to be used for residential purposes;
- where, under the CIS scheme, the 'contractor' is not required to report payment to HMRC under one of the exceptions under the Income Tax (CIS) Regulations 2005;
- where goods and services are supplied to a client who is classified as an 'end user';
- where you are providing materials or goods only;
- to 'intermediaries'. Intermediaries are generally those who (a) make onward supplies of construction services without making a material alteration to those services; and (b) are a parent or subsidiary of the 'end user'. This exception will also apply in a landlord and tenant situation where the landlord or tenant has commissioned construction services for the other party.
As a general rule, if the CIS applies then the supplier of services will need to consider whether a reverse charge will apply and whether its invoice should be raised net of VAT.
Under the CIS scheme is it relatively common for construction contracts to state whether the client/employer is 'a contractor' for the purposes of the CIS scheme. This then informs the 'sub-contractor' what it needs to do in order to receive the full payment without deduction. Similarly, providers of VATable services will now need to establish whether the reverse charge will apply. With this in mind (and in a similar vein to that of CIS), we would suggest that construction contracts should now include a provision which allows the receiver of the services to state in the contract whether:
- it is VAT-registered;
- it is an 'end user' for the purposes of the reverse charge system; and/or
- whether there are any relevant factors which will exclude the reverse charge arrangement.
Who is an 'end user'?
As mentioned above, the reverse charge system does not apply where goods and services are supplied to a client who is classified as an 'end user'. So, who actually falls into this category?
An 'end user' is a person, business or group of businesses who receives the building and/or construction services but who will not be making an onward supply of those services. This will usually mean the ultimate client who may be a: developer; the final user or occupier of the property; a deemed contractor under CIS; or, a domestic client/consumer.
HMRC has placed the onus on end users to issue their suppliers with written confirmation of their status – possibly referred to as an 'end user certificate' or 'end user notice' – and that VAT should therefore be charged in the normal way. HMRC has provided example wording for such a notice which should read as follows:
"We are an End User for the purposes of section 55A VAT Act 1994 reverse charge for building and construction services. Please issue us with a normal VAT invoice, with VAT charged at the appropriate rate. We will not account for the reverse charge."
The only exception to this rule is in respect of domestic clients or consumers, who are not required to confirm their status to suppliers but to whom VAT should continue to be charged in the normal way. For completeness, suppliers to domestic end users are advised to include a statement in their terms and conditions and their invoices as follows:
"We assume that the customer is an End User for the purposes of section 55A VAT Act 1994 reverse charge for building and construction services and we will charge VAT at the appropriate rate unless you inform us otherwise."
This is a significant change for the construction industry and some practical considerations come to mind for everyone within the supply chain:
- Communication within the supply chain will be key to the correct operation of the reverse charge system. Providers of VATable services will need to establish, at the outset, whether the reverse charge will apply or not.
- For current projects, parties need to be aware of the next interim, milestone or final invoice against which the reverse VAT charge will begin to apply to ensure that invoice is correctly raised.
- End Users need to ensure that as of 1 March 2021 they have provided their supply chain – for both new and ongoing contracts - with an 'end user certificate' or 'end user notice' confirming their status.
- Where there is a change in end user status mid-project, parties will need to be aware of the earliest date on which the reverse VAT charge will begin to apply so that invoices are correctly raised thereafter.
- For mixed service contracts, reverse charge VAT is the default position, i.e. where any of the services being supplied are subject to reverse VAT then all other services will also be subject to reverse VAT.
- All parties will need to ensure that their invoicing software / systems are capable of implementing and processing reverse VAT charging and that staff have been trained accordingly.
- Impact upon cashflow is likely to be a key consideration for Tier 2 contractors / Subcontractors who usually work for other contractors and who will therefore no longer be in receipt of VAT payments for any construction services provided.
HMRC has stated that it will apply a 'light touch' during the first 6 months of the scheme's implementation whilst the industry adapts to the change, which it is acknowledged is a significant one. It has produced guidance notes to assist in this regard which can be found here.
Further guidance has also been produced by industry body Build UK which can be found here.
If you have any queries or questions regarding this article or would like to discuss the impact of reverse VAT charging upon your contracts, please contact Jo Morris or Alan Tate in Michelmores' Construction & Engineering team.
This article is for information purposes only and is not a substitute for legal advice and should not be relied upon as such. Please contact our specialist lawyers to discuss any issues you are facing.