HMRC delay timing on implementation of the Construction Industry Reverse Charge
Why the change?
The initial target date was 1st October 2019 but that has just been pushed back a further 12 months. HMRC have listened to representatives about concerns that some businesses in the sector are not ready to implement the VAT Reverse Charge under the new regime.
To give more time to implement changes in work practices and to manage changes in cash flow, a further 12 months has been granted before the new rules will apply.
Leonard Curtis think this is a very positive move for a sector which is facing a number of challenges that are already negatively impacting cash flow. For example, the squeezing of credit ratings which is making it increasingly difficult to obtain bad debt protection cover within this sector.
The reprieve will also give more time for accountants with clients in the sector to provide valuable support through this transitional period.
For those not familiar with the scheme, we have set out below how the new regime is expected to work.
What is the Construction Industry Reverse Charge?
It’s a new way of accounting for VAT within the construction industry, which is now due to come into force on 1 October 2020.
Why is it being introduced?
It is part of a wider government clamp-down on VAT Fraud. HMRC sees the construction industry as a sector that presents a significant risk to the Exchequer, whereby contractors fail to pay over VAT they have collected on invoices from other contractors.
How will it work in practice?
In simple terms, it will mean that a contractor receiving a supply of specified construction services will not pay VAT to their sub-contractor but will account for it themselves on their own VAT returns.
The contractor receiving the supply will apply both an ‘output’ and a ‘mirror’ input VAT amount on their return – the net effect being nil for relevant transactions, hence the phrase ‘Reverse Charge’.
The sub-contractor supplying the specified construction service will supply an invoice to the contractor, excluding VAT. No VAT amount will appear on the supplier’s VAT return.
The rate applied and thus the reverse charge amount will be based on the rate of VAT that applies for the work in question but only supplies subject to either 5% or 20%.
Who is expected to be caught by the new rules?
The reverse charge will apply to VAT-registered building contractors engaging VAT-registered subcontractors and, similarly, to sub-contractors engaging others through the supply chain. A final customer for building work, such as an occupier or a developer, will not have to apply the reverse charge and will continue to incur VAT in the same way as now. For example, a retailer having their premises improved.
The reverse charge is aligned with the Construction Industry Scheme (CIS), and will only apply to supplies that are within the scope of the CIS but with some notable differences.
- Not all supplies within the CIS will be subject to the reverse charge. There will be various exclusions which will be particularly relevant to deemed contractors.
- The reverse charge will not apply to zero-rated supplies.
- The reverse charge will extend to building materials included within a supply of building work.
- Deductions under the CIS do not affect the amount of VAT. Contractors and sub-contractors include anyone who is acting in that capacity by making a supply of building work, whether or not this is their normal activity.
Are there situations where the new system will not apply?
There are certain situations, set out in the proposed legislation, where the reverse charge will not apply, otherwise, the presumption is that the reverse charge will apply. In particular, there will be no de minimis threshold for its application.
The supplier should not charge VAT unless:
- The payment is outside the scope of the CIS;
- The customer is not (and is not required to be) VAT-registered; or
- The customer is treated as or like an ‘end user’ or is not acting in a business capacity and not considered as a construction business.
Additionally, the supplier should not charge VAT if the supply is zero-rated, or if it is not VAT-registered or required to be registered.
The proposed scheme does not apply to employment/staffing agencies who are not considered to be a supplier of building work.
New obligations on contractors
Under the proposed legislation, if a supplier charges VAT, the customer needs to be satisfied that it is actually due. If VAT is charged incorrectly it will not be recoverable as input tax by the customer. This is particularly important because when HMRC disallows a VAT refund claim, the customer will need to seek recovery of overcharged VAT from the supplier which may be straightforward but can be difficult or impossible, for example, if the supplier is no longer trading.
This can be a major issue for contractors who pay VAT over in good faith but cannot recover the ‘mirror’ input VAT if it transpires the sub-contractor did fall within the framework of the new VAT scheme.
How could the new regime impact cash flow?
It very much depends whether you are the supplier of the service or the customer. If you are a small sub-contractor supplying the service, that would ordinarily manage cash flow by utilising the VAT received on invoices raised, this will create a working capital deficit.
Additionally, that same sub-contractor may now be in a repayment position as a consequence of no longer having to account for VAT to HMRC, but will have to wait for the refund to be paid over.
If you are a customer, you will not have to pay VAT on invoices raised by your supplier and when submitting your VAT return you will apply the reverse charge (as the input would normally be directly attributable to the onward supply of building work) such that the net effect is nil.
Both parties will have to ensure they have adopted polices and processes to manage the new regime otherwise there is a risk on the customer that input VAT they are trying to reclaim via the reverse charge may be rejected by HMRC on any later inspection.
There are no transitional rules for on-going projects and as such, the charge will apply wherever the tax point is for a supply. Pre-checks will have to be undertaken ahead of the new legislation coming in to ensure clients are aware of the rules and have adopted new work practices to accommodate.
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