The Final Countdown for Domestic Reverse Charge: All You Need to Know
Estimated reading time: 11 minutes
HMRC’s long due Domestic Reverse Charge for construction and property industry is coming into force on March 1st. The legislation is an anti- VAT fraud measure applicable to the Construction Industry Scheme (CIS) registered businesses providing or receiving construction services subjected to CIS reporting. To understand the full impact of Domestic Reverse Charge, specialists from Clear House Accountants have delved into the intricacies of the VAT notice 735. This guide is for general information, so it is advisable to consult a professional accountant who can help you according to your business situation.
Domestic Reverse Charge
The VAT domestic reverse charge is a change of VAT handlings and an extension of the Construction Industry Scheme CIS. However, as the name suggests, it is designed to counter VAT implications for this industry in the UK and is not applicable to cross-border services. This new measure will make the businesses in the building and construction Industry liable to pay VAT to HMRC directly when buying materials from a supplier, instead of paying the supplier.
According to HMRC, construction businesses take 5% to 20% additional profit by not paying their VAT bill on the services they supply while charging VAT for the same services. Therefore, HMRC introduced the domestic reverse charge to move the VAT charge down the supply chain and to reduce the VAT frauds in the construction sector. This is not the first time that HMRC has introduced such schemes, as there have been similar VAT reverse charge schemes for other goods and services like computer chips, mobile phones, and wholesale energy suppliers.
The domestic reverse charge covers construction services and goods involved in construction, repair, extension, alteration, and dismantling or demolition of structures/buildings or infrastructures. However, the whole change of process holds multiple technicalities and legal implications that are hard to understand for businesses in the construction Industry. For the same reason, specialists had shown concerns previously in 2019 when the reverse charge was initially planned to start in October 2019. However, HMRC postponed it to a later date to avoid confusion of the changes amidst the Brexit transitioning period. The new rules were set to take effect on October 1st, 2020, but HMRC once again postponed it to March 1st, 2021, considering the COVID-2019 Pandemic.
How Does the Domestic Reverse Charge Work?
Any construction business that is VAT registered when supplying goods or services to any other VAT registered business will have to issue an invoice mentioning the services are subject to the reverse charge. The service recipient business will be liable to account for the VAT on the supplies through its own VAT return rather than paying to the supplier. The business on the receiving end of the services can later recover the VAT as input tax given the standard rule. The business providing services will not account for output VAT in its accounting system as it has only received the amount for the supplies provided without the VAT.
The reverse charge will be applicable to the entire supply chain until the supplies (goods or services) are made to the end-user. In initial plans, HMRC was to ask the suppliers to make their own checks to confirm the customer’s status as the end-user, but this requirement was later changed in July 2020. As for now, the customers are themselves required to notify the service provider in writing about their end-user customer status.
The Impact on Businesses
Cashflow is the biggest challenge for business in the Construction Industry, as 1 in every 53 construction companies flag it as a constant problem, while 84.4% reported general cash flow problems. Experts have continuously shown their concerns regarding the negative impact of the domestic reverse charge on the cash flow of the businesses in the construction industry. Therefore it is important for businesses to review their current projects and supply chains to be prepared for the changes. A professional tax accountant can help you devise a strategy depending on the nature of the project and your position in the supply chain.
Who does the VAT Domestic Reverse Charges Apply to?
The domestic reverse charges apply only to VAT-registered businesses whether providing or utilizing goods and services that are subject to CIS. The majority guide for contractors and sub-contractors in the construction industry will have to abide by the new rules. If your CIS business is not VAT-registered, then you will not be accountable for the VAT reverse charge for construction industry but the supplier will charge you the VAT as per standard VAT rules. Moreover, it is your responsibility to notify your supplier in writing if your business is not VAT- registered.
The CIS domestic reverse charge does not apply to supplies if provided to certain customers if they are intermediary suppliers or end-users.
Intermediary suppliers are the customers who further supply the goods and services to another individual without making any material alterations to the supplies, or are linked to the End-Users. In case you are the intermediary supplier, you will be treated as an end-user and the domestic reverse charge will not be applied to you. However, you must provide your supply chain status to the supplier business in writing so they can charge you the VAT and account for it in their VAT return. Once you have notified the supplier, you will no longer have to re-issue it if the end-user changes to an intermediary supplier or vice versa.
The end-user is at the very end of the supply chain and does not make further supplies of the construction goods and services received. Businesses, or customers registered for VAT under CIS, that do not want the VAT reverse charge to be applied to the services they receive, must notify their suppliers in writing about their supply chain status. If your business customers are mostly end-users, you may want to add a statement in your company terms and conditions, to state that you will assume that the customers are end-users unless notified otherwise. The statement places a responsibility on the customers to respond and notify them about their status.
When to Apply CIS Domestic Reverse Charge
Construction Services the Domestic Reverse Charge Applies to
HMRC has clearly defined which services will be subjected to the reverse charge and which will be excluded.
- Constructing, repairing, extending, altering, offshore installation, demolition or dismantling services of building and structures. It is applicable regardless of that the structure is permanent or not.
- Constructing, repairing, extending, altering, demolition of any works that are forming, or planned to form, part of the land. This includes roadworks, walls, power lines, aircraft runways, electronic communication equipment, railways, docks, harbours, inland waterways, pipelines, water mains, reservoirs, sewers, wells, industrial plants, installations for land drainage, coast protection and defence.
- Installation of heating, air conditioning, lighting, ventilation, drainage, power supply, water supply, sanitation, fire protection systems, or lifts in any building or structure.
- Internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration.
- Internal or external renovation and painting of any building or structure.
- Any services which form or are an integral part of the above-mentioned services, including earth-moving, site clearance, excavation, laying of foundations, tunnelling and boring, erection of scaffolding, landscaping, site restoration, and the provision of roadways and other access works.
Video: Domestic Reverse Charge for the Construction Industry
The following services when supplied on their own will not be charged for Reverse charge:
- Drilling for oil or natural gas, or extraction of oil or natural gas.
- Extracting minerals using surface or underground workings. boring, tunnelling, constructing underground works for the purpose of mineral extraction.
- Manufacturing building and engineering equipment or components, materials or machinery or plant and delivery of these to site
- Manufacturing components of heating, air conditioning, lighting, ventilation, drainage, power supply, sanitation, water supply, lifts, or fire protection systems or delivering any of these to site.
- The professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants.
- Creating, repairing, or installing artworks including sculptures, murals or other artistic items.
- Signwriting and erecting, installing and repairing signboards and advertisements.
- Installing security systems, including burglar alarms, closed-circuit television and public address systems.
- Installing seating, blinds and shutters.
Exceptions on Certain Services
If you are a contractor, it is advisable to review and consider all construction contracts with a sub-contractor to avoid common mistakes. If more than 5% of contracts can be subject to reverse charge by volume or value, then the reverse charge may apply to all the contracts with that subcontractor. Similarly, if there is an element of the reverse charge in a supply, the reverse charge rule will be applicable to the whole supply.
If there is any service you are providing about which you are not sure if it can be categorised in the specified service, the reverse charge will apply as long as the recipient or customer is VAT registered and the payments are subject to CIS.
How DRC will Impact Accounting Schemes?
Flat Rate Scheme
The domestic reverse charge will affect the existing VAT schemes as well as the accounting process for businesses under CIS. Reverse charge supplies should be accounted for and reported the same as the transactions under the standard scheme. The supplies that the reverse charge applies to do not come under the Flat rate Scheme and will reduce the VAT turnover amount used to reclaim VAT. If you are a subcontractor, you may want to discuss this with your advisor to reassess the most beneficial scheme for your business.
Cash Accounting Scheme
As far as the Cash Accounting Scheme is concerned, businesses should exclude sales and purchases subject to reverse charge from this scheme as these purchases and sales will be accounted for under the domestic reverse charge provisions.
Annual Accounting Scheme
The domestic reverse charge will not have any impact on the Annual Accounting Scheme and businesses using this scheme can continue using this scheme by accounting supplies that the reverse charge applied to under this scheme.
How can a Business Prepare for the Domestic Reverse Charge?
With just a few days left, it is imperative to be prepared ahead of time to face the impacts of domestic reverse charge on your business. Our expert advisors have listed a few checks that you must make to assess the position of your business and how much DRC may affect it.
- Identify any potential cash flow issues your business might have to face after March 1st.
- You may have to implement a new invoicing system while stating that your services are subject to reverse charge
- Update your accounting software or accounting systems to ensure that it is familiar with the transactional process of both expense and purchase falling under the reverse charge scheme.
- Get your tax point right, you may consult your bookkeeping and tax services accountant to identify the right tax point for invoices issued for construction supplies.
- Double-check your client’s status in the supply chain and notify your status to other businesses that may require it.
As the date is coming closer when the domestic reverse charge is set to start, businesses in the construction industry are becoming concerned about the impact it will have on their cash flow. The measure is set to come into play, and therefore it is better to prepare then to worry. Solutions such as invoice financing, short term cash loans, credit facilities might be possible solutions. For a bespoke solution for your business speak to your accounting firm.
Anam has a degree in accounting from the Prestigious St John’s University, and works as a senior director in Clear House.
Before working in Clear House, Anam worked in various commercial roles, the last one being the VP Operations for a prestigious business organisation,working on improving the organisation’s operational efficiency, growth and high level client management.
Anam manages clients ranging from software companies to large property developers and managers. Notably, she recently worked with a large property development company building large scale developments in London and the surrounding area.