In depth

The new VAT reverse charge: how will it impact banks and funders?

Gateley Legal

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 VAT Treatment
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.

Accounting under the scheme

VAT schemes

  • Cash accounting cannot be used for CIS reverse charge.
  • Businesses will need to review their schemes. 
  • If a business is likely to become a VAT repayable business, it will be beneficial for it to move to monthly VAT returns.

 VAT payment

  • Where both the supplier and the recipient are VAT registered or should be VAT registered, the recipient is liable to account for and pay the VAT to HMRC on behalf of the supplier.
  • The supplier will not make a VAT payment on those supplies.

Invoices

When supplying a service subject to the CIS reverse charge, suppliers must show all the information that is normally required on a VAT invoice, except that:

  • A note on the invoice must make clear that the CIS reverse charge applies and that the customer is required to account for the VAT.
  • No VAT is charged on the invoice.
  • It should state how much VAT is due under the reverse charge, or the rate of VAT if the VAT amount cannot be shown, but that VAT should not be included in the amount charged to the customer.

Services that fall under the scheme: what is and isn’t included? 

Which services are within the CIS reverse charge?

  • Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services.
  • Constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, including walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours.
  • Pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence.
  • Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems 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.
  • Painting or decorating the inside or the external surfaces of any building or structure.
  • Services which form an integral part of, or are part of the preparation or completion of the services described above. This includes site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works.

Excluded services

  • Drilling for, or extracting, oil or natural gas.
  • Extracting minerals (using underground or surface working) and tunnelling, boring, or construction of underground works, for this purpose.
  • Manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site.
  • Manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems.
  • The professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants.
  • Making, installing and repairing artworks such as sculptures etc.
  • Signwriting and erecting, installing and repairing signboards and advertisements.
  • Installing seating, blinds and shutters.
  • Installing security systems i.e. burglar alarms, closed-circuit tv and public address systems.

Certain services can become included

  • If there is a reverse charge element in a supply, then the whole supply will be subject to the domestic reverse charge. 
  • If there has already been a reverse charge service between two parties on a construction site, and if both parties agree, any subsequent construction supplies on that site between the same parties can be treated as reverse charge services.
  • If there is doubt whether a type of works falls within the definition of a specified service, as long as the recipient is VAT registered and the payments are subject to CIS, the reverse charge should apply.
  • The contractor is asked to consider all construction contracts with a sub-contractor. If they can see that reverse charge applies to more than 5% of contracts (by volume or value) with that sub-contractor, then the reverse charge may be applied to all the contracts. 

How might the new VAT reverse charge affect your business?

Get in touch with our experts listed below to determine how this might affect your business and how you can prepare.

Gateley Plc is authorised and regulated by the SRA (Solicitors' Regulation Authority). Please visit the SRA website for details of the professional conduct rules which Gateley Legal must comply with.

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