From 1 October 2019 there will be significant VAT changes for Construction Industry businesses. As a result most subcontractors will not receive VAT.
UPDATE: Delay in VAT Reverse Charge for the Construction Industry until 1st October 2020
Why are the VAT changes for Construction Industry businesses taking place?
HMRC believe that the construction industry is susceptible to fraud. Namely ‘missing trader fraud’.
Missing trader fraud is where a subcontractor charges VAT to its customers but disappears after a few months of trading. As a result HMRC lose out on the VAT it is owed from the subcontractor.
The October 2019 VAT changes for Construction Industry businesses will restrict this VAT fraud. A reverse charge is to be implemented. As a result, the reporting and payment of VAT passes to the customer.
We have demonstrated these VAT changes by comparing the current VAT rules and the new VAT rules below.
VAT & CIS Useful Links
- An easy to use solver, which will inform you when to apply VAT Reverse Charge or Normal VAT rules?
- Simply enter the subcontractor CIS & VAT status, the labour and materials and the CIS Tax Deduction Calculator will work out the correct CIS deductions.
What are the current VAT rules in the Construction Industry?
The current VAT rules are those of any typical supply chain.
For example, a subcontractor invoices £1,000 plus VAT of £200 to a contractor. The contractor would pay £1,200 to the subcontractor (ignoring CIS tax).
Subcontractor VAT return:
The subcontractor would therefore include in Box 1 the VAT amount of £200. Assuming no other transactions the subcontractor would pay £200 to HMRC.
Contractor VAT return:
The contractor would therefore include in Box 4 the VAT amount of £200. Assuming no other transactions the contractor would reclaim £200 from HMRC.
NOTE: Under current rules HMRC would lose out by £200 if the subcontractor was a fraudulent missing trader.
What are the new VAT rules in the Construction Industry?
Using the simple example above.
The subcontractor would invoice £1,000 but state reverse charge VAT rules apply. The contractor would pay £1,000 to the subcontractor (ignoring CIS tax).
Subcontractor VAT return:
The subcontractor would therefore include in Box 1 a VAT amount of £Nil. They would still declare the net sale of £1,000 in Box 6 of the VAT return. Assuming no other transactions the subcontractor would not pay anything to HMRC.
Contractor VAT return:
The contractor must account for the reverse charge on its VAT return. Therefore they include it as a sale in Box 1 of their VAT return £200 and an input recovery amount of £200 in Box 4. As a result the contractor also would not pay or receive anything from HMRC.
NOTE: Under the new rules the subcontractor does not receive the £200 VAT from the customer. Therefore the missing trader fraud suffered by HMRC is avoided.
Normal VAT v Reverse Charge VAT
To decide whether ‘Normal VAT’ applies or ‘Reverse Charge VAT’ applies the subcontractor must answer these 5 questions:
- Are any of the supplies made within the scope of CIS?
- Is the supply standard rated or reduced rated?
- Is your customer VAT registered?
- Will your payment be reported under CIS?
Answering ‘No’ to ANY of the above means that ‘Normal VAT’ rules apply.
- Has your customer confirmed that they are an ‘end user’?
Answering ‘Yes’ to question 5 also means that ‘Normal VAT’ rules apply.
The ‘reverse charge’ applies for all remaining scenarios. That is to say that the answer is ‘Yes’ to ALL of the first 4 questions and the customer is NOT the end user.
The flowchart below shows the above in an illustration.
We go through some of the above questions in more detail below.
Supplies within the scope of CIS
HMRC have confirmed that the affected supplies will be the same as those deemed to fall under the construction industry scheme.
The main items included in the construction industry scheme are construction, repairs, alterations, extensions, civil engineering, painting & decorating, installation of heating, lighting and air-con.
Should the supply provided include mixed supplies the whole amount is covered by the reverse charge rules.
For further information see What work does CIS cover?
Is the customer VAT registered?
The subcontractor needs to confirm with the contractor if they are VAT registered.
The VAT number can be checked against the EU VAT records.
To find a company VAT number use the VAT-search website.
For further information on obtaining and checking VAT numbers see VAT Registration Number
Is the customer registered for CIS?
Current CIS rules mean that existing contractors should provide net subcontractors with a payment and deduction statement. This can be used to show if the customer is registered for CIS.
Where this is unavailable, HMRC have stated that subcontractors can use the CIS verification system if they are also a contractor. This system is currently used by contractors to verify subcontractors but HMRC have stated it can be used in reverse.
What is an end user?
An end user is the consumer or final customer. They don’t recharge or make onward supplies to continue the supply chain. Typically this would be the property owner.
Work completed and invoiced to an end user is charged VAT under the normal rules. For example new builds would continue to be zero rated. Other work would continue to be standard rated.
Should there be any doubt as to whether the customer is an end user the default position should be to apply the reverse charge rules.
Tip: When a supply would typically be a reverse charge, but the customer has stated that they are the end user. We recommend that the confirmation is obtained in writing from the customer.
Problems with the VAT changes for Construction Industry businesses
We foresee two problems with these VAT changes.
The first problem is an admin problem. We predict that this will be a minor issue as most software should be able to cope with the new requirements. Also with the introduction of Making Tax Digital most VAT registered businesses have already been forced into implementing software.
The invoice must now state that reverse charge applies. The HMRC example is as follows:
‘Reverse charge: VAT Act 1994 Section 55A applies’
The second problem is a cashflow problem. Businesses will no longer be able to use the VAT received from customers to fund its working capital requirements. This has the potential to be a major problem for some businesses operating on tight margins.
For example a subcontractor invoices £5,000 + VAT on 1st September 2019. The money is received from the customer on the same day. Assuming a VAT quarter of 30th November 2019, the £1,000 VAT is not paid over to HMRC until 7th January 2020. The £1,000 is therefore a source of capital for the subcontractor for over 4 months. A repeat transaction on the 1st October 2019 will not include the additional £1,000 VAT therefore reducing available cashflow.
Monthly VAT returns
Subcontractors may find themselves in the unusual position of not having to charge VAT on most of their sales. As a result they may become repayment traders.
A repayment trader is where they typically receive a repayment from HMRC on their VAT returns.
VAT repayments may become due following the VAT changes for construction industry businesses. As a result, we would recommend that these businesses apply to move to monthly VAT filings. This will therefore speed up the repayments due from HMRC.
VAT changes for construction industry and other VAT schemes
The VAT changes for construction industry businesses will affect other VAT schemes.
Businesses on either the Flat Rate Scheme or Cash Accounting may no longer be beneficial under the new rules.
As mentioned previously the VAT changes for construction industry businesses come into effect on 1st October 2019.
Transitional rules apply for invoices and payments received, which straddle this date. They are as follows:
Normal VAT rules apply when:
- Invoices are dated before 1st October 2019 with payment received on or before 31st December 2019.
Reverse VAT rules apply when either:
- Invoices are dated before 1st October 2019 with payment received on or after 1st January 2020.
- Or all invoices dated on or after 1st October 2019 with payment received on or after 1st October 2019.
Our opinion on the VAT changes for Construction Industry
We have no doubt that ‘missing trader fraud’ is an issue for HMRC. The implementation of these construction industry VAT changes will assist with this problem.
However the cashflow consequences on smaller subcontractors could be a major issue if not mitigated. If this is a potential problem for your business you must consider your options. These could include:
- What VAT scheme you are on? – Cash Accounting and Flat Rate are unlikely to be favourable under the new rules
- Changing from net subcontractor status to gross status, thus ensuring higher payments are received from customers
- Discussing payment terms with customers
- Delaying capital expenditure until 2020 when impact on cashflow is better understood
- Changing to monthly VAT returns if business becomes a repayment trader
At Patterson Hall Chartered Accountants we are experts within all aspects of the Construction Industry Scheme. We have produced an ultimate guide to all things CIS with many user friendly helpsheets and examples. Take a look at our CIS Accountants guide.
DISCLAIMER – Please note that the content contained in this article is for general information only and is not a substitute for professional advice – read our full disclaimer