VAT – Changes in the Construction Industry
Key changes in the Construction Industry:
- New VAT legislation to commence on 1 October 2019
- Main contractors will need to account to HMRC for VAT paid to its supply chain
- Works and services on zero rated projects will not be affected
- Detailed guidance will be available through HMRC
In the last week HMRC has published its draft legislation to introduce a 'reverse charge' system for VAT in the construction industry, with effect from 1 October 2019. The government initially consulted on this with the industry, on the basis that VAT payments were being fraudulently charged and not paid over to HMRC.
Under the new system in relation to certain construction services, the customer will be liable to account to HMRC for VAT rather than the supplier. This is known as a 'reverse charge'. It is in many ways a VAT equivalent of the 'Construction Industry Scheme', whereby if a contractor pays a subcontractor for construction services, the contractor has to withhold an amount of tax and pay this to HMRC, unless the subcontractor is registered with HMRC.
There is currently something of an anomaly, in that if a subcontractor is not registered under the Construction Industry Scheme, a contractor is forced to withhold amounts in relation to corporation tax, but pay over VAT to a subcontractor who effectively cannot be trusted to handover the corporation tax – the question arises as to why they should be trusted to pass VAT to HMRC in these circumstances.
The government estimates that it loses around £100 million per year, since when subcontractors provide workers to the construction sector and the main cost is wages which are not subject to VAT, the subcontractors charge VAT on their supplies but incur very little VAT themselves.
After a long consultation process with the construction industry, the draft legislation has now been published. HMRC have listened to some sensible suggestions from the industry and have made certain exceptions to the general rule of all customers having to apply the reverse charge. The problem was occurring within the supply chain of the construction industry rather than at the point of the main contractor dealing with end-user customers. Therefore, the reverse charge will only apply to services between construction businesses rather than those who use the services for purposes other than on supplying construction services, i.e. the end-user.
Further, where certain persons do receive the supplies for the purpose of on-supplying construction services, they are still exempted. This exemption focuses on connected persons who are in a landlord/tenant or licensor/licensee relationship. Finally, zero-rated supplies are also exempted from the reverse charge on the basis that there would otherwise be rather pointless administration of VAT invoices which contain no VAT.
It seems to be accepted by HMRC that there is a small minority of fraudsters and that to combat the fraud they are creating a system which will affect many innocent businesses. They have therefore proposed a very long lead time for the measures to take effect on 1 October 2019. In addition they propose to set out detailed guidance and take a 'light touch approach' for the first six months as they anticipate something of a learning curve amongst small businesses.
Main contractors need to prepare themselves for accounting for VAT under the reverse charge, especially in identifying the services with which they are being supplied. The list of services as to what is or is not caught by the need to use reverse charges is the same as per the CIS but often the subcontractor will be registered with HMRC for CIS which relieves the contractor of the need to work this out. Using the lead time for "dry runs" of the accounting could prove useful.