From 1st October 2020 the VAT reverse charge for construction industry rules will apply. Here are some FAQs on the changes and how it will affect your construction business.
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 2020 VAT reverse charge for Construction 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.
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.
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.
To decide whether ‘Normal VAT’ applies or ‘VAT Reverse Charge’ applies the subcontractor must answer these 5 questions:
1. Are any of the supplies made within the scope of CIS?
2. Is the supply standard rated or reduced rated?
3. Is your customer VAT registered?
4. Will your payment be reported under CIS?
Answering ‘No’ to ANY of the above means that ‘Normal VAT’ rules apply.
5. 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 have created an easy to use solver, which will inform you when to apply VAT Reverse Charge or Normal VAT rules? It also includes further explanations on the 5 questions that are applied.
Also we have a simply to use CIS Calculator. Simply enter the subcontractor CIS & VAT status, the labour and materials and the CIS Tax Deduction Calculator will work out the correct CIS deductions.
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 2020. The money is received from the customer on the same day. Assuming a VAT quarter of 30th November 2020, the £1,000 VAT is not paid over to HMRC until 7th January 2021. The £1,000 is therefore a source of capital for the subcontractor for over 4 months. A repeat transaction on the 1st October 2020 will not include the additional £1,000 VAT therefore reducing available cashflow.
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 reverse charge 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.
The VAT reverse charge 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 2020.
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 2020 with payment received on or before 31st December 2020.
Reverse VAT rules apply when either:
Invoices are dated before 1st October 2020 with payment received on or after 1st January 2021.
Or all invoices dated on or after 1st October 2020 with payment received on or after 1st October 2020.
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 2021 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