The new VAT reverse charge – what to do now to prepare

Although the VAT reverse charge is not due to be implemented until 1 March 2021, there are still some important factors to consider now to make sure you’re prepared for its effect. The change will have an impact on cash flow for those at the bottom of the supply chain which, in turn, may upset the stability of a project as a whole. This risk can be mitigated early by planning appropriate payment terms and project structures.

Impact on cash flow

Usually, suppliers, particularly sub-contractors, make payment of VAT to HMRC every quarter.  As such, they are able to build up cash reserves until this payment to HMRC is due.  With the new scheme, however, such monies are paid directly to HMRC by the contractor. This means that subcontractors and suppliers will lose their temporary cash reserves and will have to finance their immediate expenditure differently. 

In addition, whenever a sub-contractor procures materials, they must pay VAT on these supplies. Usually, they would be able to pass on that VAT amount to the main contractor and recover such sums in monthly interim payments. Under the new scheme, the sub-contractor is unable to charge the main contractor VAT and so will have to wait to be reimbursed by HMRC in its VAT return, if it is registered for VAT. This will lead to a delay in the recovery of such sums for sub-contractors. 

All stakeholders will be interested in mitigating these adverse cashflow consequences on the supply chain, to ensure the financial stability of the project. Sub-contractors may also become more astute in enforcing their payment terms and, therefore, more willing to use adjudication to resolve payment disputes quickly. As such, it is important to consider what measures can be taken to deal with these changes. 

Modifying payment terms

Due to the pressures on cashflow, it will be more important than ever to look at the timing and frequency of payment terms so that payment is matched, where possible, to the incurring of the expense. The stakeholders in the project should try to accommodate sub-contractors incurring the cost of materials as close as possible to the available VAT rebate (as they can no longer recover such sums within their interim payments from the contractor).  For expensive items, the contractor or employer may consider it reasonable to procure such materials themselves, rather than putting this financial pressure on their supply chain. 

The changes brought about by the VAT reverse charge will also have an impact on accounting systems and so accounting teams should also prepare for the new arrangements. This may have an impact on operational costs and the tender value of some projects.  Businesses should carry out due diligence to assess whether the VAT reverse charge will apply or not, by reviewing the type of supplies that are being made and whether the recipients of supplies are VAT registered and/or CIS registered. 

Some paying parties, such as employers and contractors, may decide that payment terms need to be made longer temporarily to allow accounting teams time to get up to speed with the changes. Any revisions to payment terms should be reflected in the construction contracts. Also, if there is any doubt on whether the VAT reverse charge applies or not, the parties may consider requesting a deposit (such as a retention account) so that monies can be temporarily held whilst any financial reconciliation is made. Such decisions, however, should be balanced against the need to protect supplier cashflow. 

Addressing contractual risk

The parties may wish to amend their contracts to provide for greater certainty on whether or not the VAT reverse charge applies. For example, a supplier may require a warranty from the recipient of any supplies that they are an end-user so that the supplier has comfort that they do not need to apply the reverse charge.  
Construction contacts are well advised to consider these implications early and to use the lead-in time until the implementation of the VAT reverse charge to be well prepared for the changes. 

Article edited 18/02/21