How to apply the VAT reverse charge for construction services

Major changes to CIS announced!

Domestic reverse charge or DRC is going to be the new way of accounting for
VAT in the construction industry, a change announced by HMRC as an anti-fraud measure.

This change has been delayed twice due to Brexit and COVID-19 but now it is set to go ahead on 1st March 2021.

How could this affect you?

If you are VAT registered in the construction sector in the UK, it will apply to you

The reverse charge will affect you if you are:

  • registered for VAT
  • you supply or receive services under the Construction Industry Scheme (usually known as CIS)

What is the change?

As it is now, a sub-contractor (builder) supplies services and building materials to a contractor (construction firm) and the seller must charge for VAT and declare the VAT to HMRC through their VAT return submission.

After 1st March, a sub contractor (builder) supplies services to a contractor (construction firm) and under the new rules, the contractor must declare the VAT due on their VAT return and reclaim it subject to normal rules.

In short the legislation moves the VAT liability from the supplier (subcontractor) of a service in the construction industry to the customer (contractor).

Exemptions

There are some exemptions to Domestic Reverse Charge.

The reverse charge does not apply to any of the following supplies:

  • Supplies of VAT exempt building and construction services.
  • Supplies that are not covered by the CIS, unless linked to such a supply.
  • Supplies of staff or workers.

The reverse charge does not apply to taxable supplies made to the
following customers:

  • A non-VAT registered customer.
  • ‘End Users’ i.e. a VAT registered customer who is not intending to make further on-going supplies of construction.
  • ‘Intermediary suppliers’ who are connected e.g. a landlord and his tenant or two companies in the same group.
  • Overseas customers. It only applies to UK companies providing building and construction services in the UK.

What do you need to do to prepare?

Invoicing:

If you are a VAT-registered subcontractor (supplier) who provides building and construction services to a VAT-registered contractor (customer) who is CIS-registered then you no longer need to account for the VAT. Instead, your invoices should inform your customer that the VAT reverse charge is applied and they are responsible for the VAT using the reverse charge procedure.

If you are a VAT-registered contractor (customer) you will instead account for both input and output tax on invoices you receive from your VAT-registered subcontractors.

Your Accounting Software:

If you use accounting software you’ll need to check it will deal with the new VAT domestic reverse charge. For example, if you are using desktop software, you will need to check with your supplier if a manual update is available.

If you already use Xero, you’re all set because it has already been updated to help you comply with DRC.

If you don’t currently use software for your business then this is a great time to start. Using cloud accounting software like Xero makes life a whole lot simpler especially when dealing with CIS and VAT.

Your cashflow forecast:

Consider whether the change will impact your cash flow. If you are a subcontractor then it’s likely your cash flow will be impacted as you will no longer be receiving the VAT payment from your customer.

If you are the contractor, you will likely have a short term cash flow benefit as you will no longer be paying the VAT amount to the subcontractor, however you must remember you will need to account for VAT as output tax (box 1) as well as input tax (box 4), along with the rest of your VAT accounting. Remember to reach out to your accountant who will be able to help should you need it.

Your staff and customers:

Make sure all of your staff who are responsible for VAT accounting are aware of the reverse charge and how it will work. If you are a contractor you should also be proactive in contacting your VAT registered subcontractors prior to the 1 March 2021 to ensure they are aware of these changes and don’t invoice you for VAT.

Likewise, if you are a subcontractor be sure to contact your contractor customers to make them aware you will be applying the domestic reverse charge to invoices from 1 March 2021.

Below are some useful links which breaks everything down, section by section:

When you must use the VAT reverse charge for building and construction services – what you need to do, how to prepare, when you must and must not use the reverse charge:
https://www.gov.uk/guidance/vat-domestic-reverse-charge-for-building-and-construction-services

A technical guide to the VAT reverse charge if you buy or sell building construction services:
https://www.gov.uk/guidance/vat-reverse-charge-technical-guide

How to use the VAT reverse charge if you supply building and construction services and what you’ll need to do:
https://www.gov.uk/guidance/how-to-use-the-vat-reverse-charge-if-you-supply-building-and-construction-services

A Suppliers flowchart which demonstrates how you would decide whether to apply normal VAT rules or whether to apply the domestic reverse charge:
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/878587/Annex_1_-_VAT_domestic_reverse_charge_for_building_and_construction_services.pdf

Employment businesses supplying construction workers:
https://www.gov.uk/guidance/vat-reverse-charge-technical-guide#employment-businesses-supplying-construction-workers

Specified construction services (CIS 340). This guide explains the duties of both contractors and sub-contractors within the Construction Industry Scheme:
https://www.gov.uk/government/publications/construction-industry-scheme-cis-340

VAT for builders – this includes houses and flats, building new homes, work for disables people, energy saving and mobility aids and other types of building:
https://www.gov.uk/vat-builders

VAT and CIS registration checks – when to check if your customer is VAT and Construction Industry Scheme registered or an end user:
https://www.gov.uk/guidance/vat-reverse-charge-technical-guide#when-to-check-if-your-customer-is-vat-and-construction-industry-scheme-registered-or-an-end-user

Check a UK VAT number – if a UK VAT registration number is valid, the name and address of the business the number is registered to:
https://www.gov.uk/check-uk-vat-number

CIS online – you can sign up or log in to file your monthly returns as a CIS contractor, or to verify a subcontractor:
https://www.gov.uk/use-construction-industry-scheme-online

CIS software – guidance to finding recognised software suppliers for the Construction Industry Scheme (CIS):
https://www.gov.uk/government/publications/construction-industry-scheme-cis-commercial-software-suppliers

End users and intermediary supplier businesses:
https://www.gov.uk/guidance/vat-reverse-charge-technical-guide#end-users-and-intermediary-supplier-businesses

Invoices and other VAT documents:
https://www.gov.uk/guidance/vat-reverse-charge-technical-guide#invoices

VAT Returns – an overview, filling in your return, how to submit your return, deadlines, surcharges and penalties, assessments and interest on underpaid or overpaid VAT:
https://www.gov.uk/vat-returns

Monthly VAT Returns – changes to cash flow and monthly returns:
https://www.gov.uk/guidance/vat-reverse-charge-technical-guide#changes-to-cash-flow-and-monthly-returns

(Sources: HMRC.gov.uk, Xero January 2021)