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Questions build around DRC rules for construction

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Hilary Bevan looks at the common questions and pitfalls that have arisen since the new VAT domestic reverse charge (DRC) rules came into effect for the construction industry.

22nd Jun 2022
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Since the new domestic reverse charge (DRC) rules came into effect for the construction industry on 1 March 2021 there has been confusion over whether the required conditions have been met.

First, let’s have a recap. The DRC rules only apply when all five of the conditions are met:

  • Supply is one of specified services within the scope of the Construction Industry Scheme (CIS)
  • Supply is standard rated or reduced rated
  • Customer is (or should be) VAT registered
  • Customer is CIS registered
  • Customer is making an onward supply.

If any one of those conditions is not met, the reverse charge does not apply and VAT should be charged by the supplier as normal. This is shown quite helpfully on HMRC’s flowchart.

Where the reverse charge applies, the supplier does not charge VAT on the invoice. Instead, the customer declares the VAT themselves by including it in box 1 on their next VAT Return. The VAT may then be recoverable by them in box 4, subject to the normal rules.

If VAT is charged and it shouldn’t have been, there is a risk to the customer that HMRC will disallow recovery of the VAT.

If VAT is not charged and it should have been, there is a risk to the supplier that HMRC will raise an assessment in respect of VAT undercharged.

Where my clients have had issues with this, it generally comes down to a difficulty in establishing whether one or more of the five conditions have been met.

Standard or reduced-rated supply

It is still the responsibility of the supplier to establish the VAT rate applicable to the transaction, even if they are not the ones who account for it to HMRC.

Is customer VAT registered?

Where the customer is VAT registered, this is fairly easy to establish, as they can provide their VAT registration number to the supplier.

If they are not VAT registered but should be, how on earth is the supplier supposed to establish that if the customer, who actually has all the relevant information in front of them, hasn’t realised it?

In some circumstances, it may be prudent for the supplier to obtain a statement from the customer along the lines of: “We confirm that we are not VAT registered and are not required to be”. That puts the ball back in the customer’s court should HMRC question the treatment.

It is worth noting that whereas usual reverse charge supplies count towards the customer’s VAT registration threshold, in this case they do not. Those supplies do, however, count towards the supplier’s VAT registration threshold, so registration would still be required, even if all supplies made fell within the reverse charge rules.

Is customer CIS registered?

Once again, the supplier must rely on information provided by the customer.

Be aware that a business is treated as a building contractor for CIS purposes if it spends more than £3m on building work in a 12-month period and so some businesses that do not at first glance appear to be in the construction industry may be caught.

It is possible to check CIS status online with HMRC.

Making an onward supply

For the reverse charge to apply, the customer must not have notified the supplier that they are the end user or an intermediary in relation to the supply. If the customer has notified the supplier that they are an end user or intermediary, the reverse charge will not apply and the suppliers should charge VAT.

The main issues I have seen around this condition come down to a lack of communication between the two parties. The supplier may have understood the customer was not the end user but the customer has said they are.

In other cases, the supplier was led to believe the customer is the end user but customer has not made an end-user notification. The key point is not whether the customer is the end user but whether they have notified the supplier they are the end user.

To avoid future problems, try to have a frank and open dialogue with your customer/supplier and ensure all discussions and conclusions are documented.

Specified services

This is by far the condition that has provoked the most questions.

HMRC does provide a list of specified services but, of course, most activities that happen in real life do not neatly fall under any of the descriptions.

The difficulty is that the list of specified services is taken from the CIS rules, which the person dealing with the VAT may not have any experience of. Until last year, I had successfully avoided having to know anything about CIS tax so it has been a steep learning curve for me as well.

The information I have found most helpful is actually in HMRC’s CIS guidance, rather than their VAT guidance. In CISR14330, HMRC provides an alphabetical list of different types of work. Each one links to a more detailed explanation and a lot of examples of when those types of activities will be caught by CIS and when they will not.

It is a hugely valuable resource and I would suggest it as a first stop for anyone trying to establish whether a supply is or isn’t a specified service.

Replies (18)

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By Paul Crowley
22nd Jun 2022 12:41

Really helpful with useful links
Much appreciated

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Replying to Paul Crowley:
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By Geoff56
22nd Jun 2022 16:43

+1

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By rmillaree
22nd Jun 2022 19:41

Top banana stuff

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By johnjenkins
23rd Jun 2022 09:20

The easiest thing would be to have no vat transactions between registered business. Don't forget VAT is not a tax on business (unless you turnover less than £85K.)

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Replying to johnjenkins:
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By rmillaree
23rd Jun 2022 09:38

"Don't forget VAT is not a tax on business (unless you turnover less than £85K.)"

If i have 84 sales and 10k profit year one
and 86k sales and nil profit year 2 due to 10k approx vat being payable with everything else being as it was.

Its hard probably possibly even "stupid" to argue that this business has not been taxed and taxed very heavily despite being over the vat threshold now. Facts are this business is paying out 10k it wouldnt have done and hmrc get 10k it would not have done had the business not had 2k extra sales. Ok the reasons is they had teh prior "free lunch"which has ben removed but i wouldnt want to say to any suhgc client they are not being "taxed" heavily when the fact is that they are (compared to previously)

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Replying to rmillaree:
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By johnjenkins
23rd Jun 2022 09:57

Your scenario is called "the cliff hanger". Many at that stage choose to have a day off or whatever to keep their turnover below the threshold.
My view is, and always has been, that all business should be vat registered with no VAT changing hands between registered business so only Joe Public pays (which is what VAT was all about). However HMRC would lose a lot of dosh.

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By pictures
23rd Jun 2022 09:38

The problem we are having is that some of our customers (who are major facilities managment companies) are refusing to pay any invoice unless the DRV is applied, even though in the majority of cases we are providing work that does not come under the scope of CIS eg servicing

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Replying to pictures:
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By rmillaree
23rd Jun 2022 10:23

The trick here is to slap em in the face with facts - if company is emailed concrete guidance cis does not apply then they will back down or simply provide you with no work thats your choice unfortunately - so practicably speaking sometimes sucking it up is easier. I have seen no company to big to take down when they are wrong as someone has responsibility to not get it wrong if you know you are right.

In their deference the line is often fine ref servicing and cis that practicably speaking it may be easier to go with the flow - i feel sorry for the poor peeps paid little procesing these transactions needing top level + knowledge of teh rules- get formal agrement work may have cis and non cis elements and both parties agree this being case its all DRC.

Note similar tends to happy when electricians and plumbers are paid - if you dig inton the cis manual they can be exempt ref repairs tro certain stuff - but possibly its more common than not for that stuff to be treated as being cis.

If company is known to be paying under cis i would not want to be arguing to vat office that work is non cis and that drc does not apply if custoemr is saying otherwise.

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By North East Accountant
23rd Jun 2022 09:39

Regarding condition 4-Customer is CIS registered.

What's the treatment if the customer is not CIS registered but should be?

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Replying to North East Accountant:
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By karenah
23rd Jun 2022 10:12

This is what I'd like to know too... I'm coming across this a lot. I contacted HMRC about it, who were clueless as usual, and just said they'd catch up with those who aren't CIS registered!

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Replying to karenah:
Hilary Bevan
By Hilary Bevan
23rd Jun 2022 13:43

The legislation specifically says that excepted supplies are “supplies of specified services in respect of which a payment is not required to be included in a return made under regulation 4 of the Income Tax (Construction Industry Scheme) Regulations 2005.” (SI209/892, art 8(1)(a)). That means that un-excepted supplies are those which are required to be included in a return. That suggests to me that it does mean those who should be registered will be caught, not just those who are registered.

As with the VAT registration though – I don’t know how the supplier would be expected to establish that if the customer hasn’t realised.

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By Azvaldo
23rd Jun 2022 09:49

What if the person is Gross Status for CIS. What happens then? Does it invoice VAT as normal or reverse charge?

Also in regards to lift or elevator repair and maintenance is outside the scope of CIS so i am guessing that DRC would not apply for companies like these?

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Replying to Azvaldo:
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By rmillaree
23rd Jun 2022 10:06

"What if the person is Gross Status for CIS. What happens then? Does it invoice VAT as normal or reverse charge?""

Gross status has no relevance ref DRC - DRC equally applies for DRC in the same manner as non gross status.

"Also in regards to lift or elevator repair and maintenance is outside the scope of CIS so i am guessing that DRC would not apply for companies like these?"

Let the DRC flowchart be your friend (copied below) - if it aint cis it isnt DRC by default **

The mixed contracts element is probably the only bit that Hilary didn't comment on that needs to be "known" by peeps. For cis purposes on mixed contracts non cis work may be brought within cis - that is the elephant in the room when decision need to be made ref cis or not - none of teh guidance in that regard is particularly clear. Main thing is dont do owt without both parties agreeing whetehr cis and reverse charge applies - that should be settled before any invoices are ever issued !

** There is a quirk here in that if work aint cis therefore non DRC and other work is being done that is cis/DRC for same contractor - both parties can agree to treat everything as being DRC even though technically some of the work might be non DRC based on cis rules alone

https://assets.publishing.service.gov.uk/government/uploads/system/uploa...

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By jon watkin
23rd Jun 2022 12:18

A manufacturing business (customer) engages a construction firm (subcontractor) to supply construction services falling under the scope of CIS and
the total value supplied of all construction services purchased is well under the £3m in any 12 month period and
the customer is obviously the end user but has not expressly told the subcontractor as such.

It's basically for various building works on a manufacturing site

Is the customer obliged to register under the CIS Scheme ?
Do the services purchased qualify for DRC or otherwise be standard rated for VAT?
Must the customer verify the subcontractor under CIS rules to qualify for DRC, even if the customer cannot do so because they themselves are not registered under CIS?

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Replying to jon watkin:
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By rmillaree
23rd Jun 2022 12:56

"A manufacturing business (customer) engages a construction firm (subcontractor) to supply construction services falling under the scope of CIS"

This work is not "under the scope of cis" as cis does not apply ! explanation below

Ok confirmed not deemed contractor.

Cis can only apply if engager is "contractor" - as the engager is not involved in "construction services" other than getting work done on their sites its crystal clear to me that cis does not apply as the engager is nota "contractor for cis purposes" . As cis does not apply any work that would come within cis if cis had applied is not relevant/ignored ref cis . Its simply non cis end of.
This is confirmed in
CISR12020
CISR12030
CISR12040

CISR12030 says the folowing

Under the Scheme, the following businesses and individuals are NOT contractors:
Businesses or other concerns outside the mainstream construction industry whose average annual expenditure on construction work over the last rolling 12 month period does not exceed £3 million (See CISR12050 for more information about this).

https://www.gov.uk/hmrc-internal-manuals/construction-industry-scheme-re...

"Is the customer obliged to register under the CIS Scheme ?"
Nope for reasons outlined above

"Do the services purchased qualify for DRC or otherwise be standard rated for VAT?"
standard rated vat - DRC only applies when cis applies - see above link to flowchart.

"Must the customer verify the subcontractor under CIS rules to qualify for DRC, even if the customer cannot do so because they themselves are not registered under CIS"
As cis does not apply none of the cis rules come into play - work done is like any other invoice for services that is not cis related. No verifications needed.

Note subcontractors may not know that "engager" isnt within cis - so when engaging subcontactors the contractor should upfront make clear the work undertaken will not be within in the scope of cis as we are not a company within the scope of cis. This being the case please charge vat as normal (no DRC) - if you have any queries in this regard please contact opurselves for further clarification - blah.

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Replying to jon watkin:
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By rmillaree
23rd Jun 2022 12:56

"A manufacturing business (customer) engages a construction firm (subcontractor) to supply construction services falling under the scope of CIS"

This work is not "under the scope of cis" as cis does not apply ! explanation below

Ok confirmed not deemed contractor.

Cis can only apply if engager is "contractor" - as the engager is not involved in "construction services" other than getting work done on their sites its crystal clear to me that cis does not apply as the engager is nota "contractor for cis purposes" . As cis does not apply any work that would come within cis if cis had applied is not relevant/ignored ref cis . Its simply non cis end of.
This is confirmed in
CISR12020
CISR12030
CISR12040

CISR12030 says the folowing

Under the Scheme, the following businesses and individuals are NOT contractors:
Businesses or other concerns outside the mainstream construction industry whose average annual expenditure on construction work over the last rolling 12 month period does not exceed £3 million (See CISR12050 for more information about this).

https://www.gov.uk/hmrc-internal-manuals/construction-industry-scheme-re...

"Is the customer obliged to register under the CIS Scheme ?"
Nope for reasons outlined above

"Do the services purchased qualify for DRC or otherwise be standard rated for VAT?"
standard rated vat - DRC only applies when cis applies - see above link to flowchart.

"Must the customer verify the subcontractor under CIS rules to qualify for DRC, even if the customer cannot do so because they themselves are not registered under CIS"
As cis does not apply none of the cis rules come into play - work done is like any other invoice for services that is not cis related. No verifications needed.

Note subcontractors may not know that "engager" isnt within cis - so when engaging subcontactors the contractor should upfront make clear the work undertaken will not be within in the scope of cis as we are not a company within the scope of cis. This being the case please charge vat as normal (no DRC) - if you have any queries in this regard please contact opurselves for further clarification - blah.

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Replying to rmillaree:
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By jon watkin
23rd Jun 2022 13:27

Thanks. The key take for me on this is "DRC only applies when cis applies" and the need to make this plain to any subcontractor.

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By GHarr497688
23rd Jun 2022 17:36

For a small one man band this stuff is far too complex and time consuming. A business with a turnover of less than £350,ooo should not be expected to comply but carry on in the old way. The Turnover could be the last annual accounts figure and if non-compliance then a Director should face personal consequences. The DRVC rules with the CIS rules for many are beyond comprehension and penalise many honest people for the few that are corrupt. As the commentator stated why should any VAT registered business to business need to bother with VAT at all. All these "add ons" by HMRC people who have nothing better to do are so complex they cause more errors than stress than they are worth.

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