Caution: Return of domestic reverse charge ahead
In the first part of a new series dealing with the compliance challenges facing construction in 2021, Tania Rowe explains how the industry is gearing up for a major VAT change that has already been delayed twice: the domestic reverse charge.
The construction industry domestic reverse charge (DRC) was originally planned to come into effect from 1 October 2019. It was delayed until 1 October 2020 and it is now planned to commence on 1 March 2021.
The HMRC guidance on the construction VAT reverse charge went through several iterations, and since the last delay announcement the latest version gained an unexpected addition, the 5% disregard, which makes the guidance harder to implement.
The 5% disregard means that the DRC element of a contract has to be calculated as percentage of the entire contract value to determine whether the charge applies to that contract.
What does it apply to?
The DRC applies to “construction operations”, which broadly matches the definitions currently in place for the construction industry scheme (CIS), with the notable exception of employment agencies.
The charge operates by excluding VAT on amounts charged to clients within construction operations, unless the client is an “end user”.
This is broadly translated as the person who is either receiving the construction operations for their own property, or for an associate of theirs. VAT is still calculated and recorded on the invoice along with appropriate wording stating the DRC applies. It is the duty of the end user to make their status known.
The recipient of the DRC must report the VAT that they have not been charged, but which was itemised on their invoices, as both input VAT and output VAT on their returns. That business is recognising the purchase of the goods or services from the supplier and the sale on to the client in their returns. However, they only report the net relating to the inputs, not the net relating to the outputs, and for those supplying services, they only report the net and not the VAT, thus creating lopsided VAT returns.
The DRC creates quite a few operational problems.
The whole construction industry has to understand that invoices from the point the legislation comes into force (there are transitional procedures too) that VAT is no longer charged and paid on services provided - unless the client is an end user.
As the timetable keeps moving this has already been communicated twice and delayed twice. The stop-start implementation created expectations that the DRC will be delayed again, although the awareness of the measures is now probably more widely known about now than it was in 2019.
Suppliers also need to be prepared, because they are no longer getting paid VAT by the client, and up to three months later they pay that VAT on to HMRC.
The supplier loses the cashflow benefit of holding up to 20% of their margin for a while, which many small companies may have been relying on. In an industry where margins are already small and many companies regularly go out of business, this could be quite disastrous for some.
What action to take?
Clients need to notify the supplier that they are an end user. If they do not. then the DRC will apply, meaning they will be notified what VAT applies, but they will not be charged with VAT.
Some clients, such as those who fall within this legislation because they have received construction operations over £1m for three consecutive years, may not be aware of this fact.
This is a new concept and we have been working with our construction clients to collect end user to treat our supplies the correct way once the legislation becomes effective, as are many other contractors. We have completed this exercise twice already now, but clients keep changing, so we will have to do this exercise again soon.
How to accommodate these changes
Client invoicing systems have to be enhanced to allow them to calculate and print invoices that show the VAT as a note. They need to print a statement that the DRC applies and exclude the VAT from the total payable. The accounting system also has to post VAT in different ways depending on whether an end user declaration is held or not.
Supplier invoicing systems have to maintain additional details in their supplier database, not only as to whether the CIS applies to that supplier (and at what rate), but also whether the DRC applies to that contract with that supplier. It also has to record the VAT that applies to the invoice, although it is not payable, and record that VAT so that it can be it can be included in the VAT return.
Fortunately, my tax team managed to get our MTD for VAT project completed before the pandemic hit, so that all our transactions flow directly into our VAT return to HMRC. These changes are however an additional iteration to allow the DRC to apply the same way and require additional resources to complete.
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Tania spent ten years as a Project Accountant before moving to Tax. She then spent 17 years working for Whitbread as a CT manager, principally involved in compliance and M&A work, and for the last 9 years has worked for Willmott Dixon and is responsible for all areas of tax.