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VAT: Basic guide to the reverse charge

Neil Warren explains exactly how the VAT accounting will work for the domestic reverse charge on construction services, which is due to take effect on 1 October 2019.

3rd Sep 2019
Construction and renovation tools
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A senior partner at a medium-sized accountancy firm admitted to me last week that he couldn’t grasp how the reverse charge for VAT works in practice.

It has not been particularly important for his day-to-day work in the past, but the new rules for the construction industry taking effect on 1 October will definitely change that. He needs to get a grip on what is happening.

Below is a worked example that I used to explain the charge:

Example

A typical construction transaction which will be caught after 1 October is as follows: Subcontractor Steve has done £2,000 of decorating work (including materials) for Contractor Clive – the latter will invoice the building owner for the project in question. Steve’s work is captured by the new rules because it is a builder-to-builder supply.

Current procedures

Currently, Steve charges Clive £2,000 + £400 VAT and includes £400 on his VAT return as output tax (Box 1) and the net sale of £2,000 in Box 6. Clive pays him £2,400.

Neither Steve nor Clive use the flat rate scheme.

Clive will claim input tax of £400 in Box 4 of his VAT return and record the net expenditure of £2,000 in the inputs Box 7.

New rules

From 1 October 2019, Steve will invoice Clive for £2,000 with no VAT included, noting on his invoice that Clive must deal with the VAT on his own VAT return by doing the reverse charge.

The key point with the new rules is that the same boxes will be completed overall but the Box 1 entry just moves from Steve’s VAT return to Clive’s return – that is the only change.

This is because Clive will pay Steve just £2,000 from 1 October and not £2,400, so Steve has no VAT money to include on his return.

Overall, HMRC is still receiving Box 1 and Box 4 entries for £400 and Box 6 and Box 7 entries for £2,000 ie the status quo.

Input tax

For Clive, the only difference to his VAT return is that he now has an entry of £400 in Box 1 that he didn’t have before. The Box 4 and Box 7 entries are unchanged.

But there is one subtle difference: any business claiming input tax in Box 4 must hold evidence to support the claim, which must be produced to HMRC if requested.

Under pre-October 2019 rules, this evidence was the purchase invoice from Steve which showed £400 VAT. From October 2019, Clive’s evidence is his own output tax declaration in Box 1 of the same return, supported by Steve’s invoice.

Clive must still consider the issues of partial exemption, non-business and private use before he makes his input tax entry. This is not relevant here because the £400 VAT relates to an onward supply of taxable building services to the property owner.

How to apply the reverse charge

There are three things to remember:

  1. The reverse charge rules only apply to work that is subject to VAT at either 5% or 20%. It doesn’t apply to work that is zero-rated.
  2. The reverse charge doesn’t apply when the supply consists only of materials. There must be an element of labour involved, but then the reverse charge extends to the whole invoice, including the cost of materials supplied.
  3. The builder must make it clear on their sales invoice that the customer must make a reverse charge entry, ideally specifying the amount of VAT or at least the rate that applies to the work.

Cash flow hit

With the exception of the flat rate scheme (which all builders should review), the new reverse charge rules do not alter the net or gross profit of any builder. But there is a potential cash flow hit: if Steve is on the cash accounting scheme and received £400 VAT from Clive on 1 April 2019, this would give him useful working capital until 12 August 2019 if he is on calendar VAT quarters and pays his VAT by direct debit. After 1 October 2019, this working capital boost is lost.

Replies (11)

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By marcovercelli
04th Sep 2019 10:30

Does the reverse charge apply just to firm under the CIS rules?

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Replying to marcovercelli:
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By johnjenkins
04th Sep 2019 10:44

Yes

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By johnjenkins
04th Sep 2019 10:47

Good article Neil. A bit more advice would be that those subbies on the flat rate scheme who turn over under £85k need to think about de-registering, which is what I think reverse charge is partly about.

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By m14s4k
04th Sep 2019 11:11

Excellent summary thank you. Presumably if Steve makes an error in his bill to Clive then Clive should process the bill with whatever incorrect VAT rate is applied in Steve's bill?

Also under CIS payroll processing, the CIS deduction would apply to labour excluding materials, but VAT will now not be added back to the net payment to the subbie because RC will apply to the whole subbie invoice including materials. Is that right?

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Replying to m14s4k:
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By rmillaree
04th Sep 2019 12:40

"Presumably if Steve makes an error in his bill to Clive then Clive should process the bill with whatever incorrect VAT rate is applied in Steve's bill?"

I would have presumed exactly the opposite, albeit there is i think specific leeway given for those getting up to speed making a genuine error.

As ever the vat officers will be forced into addressing knowingly wrong vat treatment i would again presume - so any wrong treatment is likely to be an issue and that's the problem here working out whether the reverse charge deffo applies or not and even if it doesn't the vat rate may also be up for grabs too. At its most simplistic if Steve Bills clive vat in error and clive pays and claims back that vat that's the worst possible scenario for clive as output vat has been understated and steve owes him money back to cover that understated output vat and steve may not be around to pay it back at a later date.

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By Lisaskinniehorse
04th Sep 2019 13:20

I have read recently that businesses will no longer be able to use the Cash Accounting Scheme under the DRC and will have to migrate to invoice-based VAT accounting. Is this true?

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Replying to Lisaskinniehorse:
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By rmillaree
04th Sep 2019 15:08

"I have read recently that businesses will no longer be able to use the Cash Accounting Scheme under the DRC and will have to migrate to invoice-based VAT accounting. Is this true?"
Do you have a link to where you read that?

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Replying to rmillaree:
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By EJonesFM
04th Sep 2019 19:52

I believe this comes from the GOV explanation here under the Cash Accounting sub-heading : https://www.gov.uk/guidance/vat-domestic-reverse-charge-for-building-and...

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Replying to EJonesFM:
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By Lisaskinniehorse
04th Sep 2019 20:02

It was mentioned in the Tax Adviser Magazine (September issue) on the ATT Welcome page 'Sandy feet a distant memory'.

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By EASTIE
04th Sep 2019 19:19

Staying on cashflow, a point to consider for clients on standard quarterly reporting is moving them to monthly returns as they may move from a net payment to a net repayment position

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By Melissa123
06th Sep 2019 16:09

HMRC have postponed it until next year!!

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