Coming down the track in Q1 next year is the introduction of the construction industry’s new VAT reverse charge. This has the potential to significantly impact the sector as well as the banks and funders who finance businesses which fall into these categories, specifically in terms of what the supplier (sub-contractor) notes upon the invoice and/or on the application.
An overview of the scheme
The Construction Industry Scheme (CIS) VAT reverse charge will apply to construction services from 1 March 2021. The aim of the measure is to reduce VAT fraud in the construction sector. The measure was due to commence in October 2019 but has been delayed twice due to Brexit and Covid-19.
The key principles of the scheme will be:
- When the reverse charge applies the customer accounts for the supplier's output VAT.
- This measure only applies to construction supplies made by a business to business.
Key conditions to the scheme
The reverse charge is to be applied when all the following are met:
- The supply for VAT consists of construction services and materials;
- It is made at a standard or reduced rate of VAT.
- Supplier and customer are both UK VAT registered and registered for CIS;
- The customer will be making an ongoing supply of construction services to another party;
- The supplier and customer are not connected.
The CIS 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;
- Supply of staff or workers.
The CIS 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 ongoing supplies of construction;
- 'Intermediary suppliers' who are connected e.g. two companies in the same group.
As can be seen, all this requires significant change for many CIS businesses:
- Staff will need to be trained to identify relevant CIS contracts and end users;
- Accounting and bookkeeping systems will need to be modified to cope with the new invoicing and reporting obligations;
- The use of the VAT Flat Rate Scheme and cash accounting may not be possible;
- Cash flow will be affected and those at the start of the supply chain may become VAT repayment claimants: they may consider filing monthly returns.
Example: How the CIS reverse charge works in practice
ABC Ltd [“ABC”], the sub-contractor who is VAT registered supplies the materials and installs insulation in a new office building for XYZ Ltd [“XYZ”] who is also VAT registered and, in turn, supplies its construction services to “the developer”, also VAT registered. The developer finds and develops land and then hands over, once complete, the finished commercial building to an end user, its client.
ABC would under the old VAT system invoice XYZ £120 comprising of his £100 bill for materials, labour and works, plus £20 in VAT (at 20%).
However, from March 2021, under the new CIS reverse charge mechanism, the process will be that:
- ABC will invoice £100. The invoice states that 'the CIS reverse charge applies and that the applicable rate of VAT is 20%’.
- XYZ will pay ABC the net £100. They will then account for output and input VAT of £20 on the supply on its own VAT return.
- ABC will not account for output VAT having only invoiced their fee of £100.
- As a consequence of the reverse charge procedure, ABC will charge and receive £20 less than under the old system (where they would charge £100 + VAT). They will not need to account to HMRC for any output tax on the transaction.
- When ABC are paid by XYZ, they will include the value of the sale in box 6 of their VAT Return. They do not add VAT to box 1 as they receive no output VAT.
- The change may well impact ABC’s cash flow, as under the old rules, if XYZ were a prompt payer ABC could hope that they could use the £20 in VAT to purchase materials. ABC would then be able to purchase materials and offset the input tax paid against output VAT.
- XYZ has a cash flow advantage; it does not have to pay ABC the £20 and then at the end of its VAT quarter it cannot reclaim £20 as it is accounting for the reverse charge and the output VAT offsets the input VAT.
- As XYZ is supplying CIS services they will also need to consider the reverse charge. Will their client, the developer, be involved in the onward supply of CIS services? In this scenario, this may be difficult to determine as apparently the developer is selling a finished building to an end user as an investor and the reverse charge does not apply. It is the developer's responsibility to notify down the supply chain.
Treatment of existing contracts to be ready for 1 March 2021
The VAT treatment is determined for payments due on any supplies entered into your accounting system before 1 March 2021, but paid on or after 1 March 2021.
|Date entered in customer’s accounting system
||Date payment made
|Before 1 March 2021
||On or before 31 May 2021
||Normal VAT rules
|Before 1 March 2021
||On or after 1 June 2021
||Domestic reverse charge
|On or after 1 March 2021
||On or after 1 March 2021
||Domestic reverse charge
For contracts starting after 1 March 2021, you should decide whether the reverse charge applies from the start of the contract.