Domestic Reverse Charge 5: How it impacts VAT schemes
Neil Warren explains the effect of the new domestic reverse charge rules on users of the VAT flat rate scheme for small businesses and the VAT cash accounting scheme.
Three different rates for builders
The flat rate scheme (FRS) has always been complicated for builders. Such businesses can fall into two different flat rate categories depending on their purchases of building materials in each VAT period, with flat rates of 9.5% or 14.5%.
Labour only builders may fall into the category of a ‘limited cost business’ with its barely tax-efficient flat rate of 16.5%.
Leave the scheme?
All construction industry sales invoices that are captured by the new domestic reverse charge rules are excluded from the VAT return of a scheme user. There is no tax to pay in box 1, and the net sales value is excluded from box 6 (outputs) of the VAT return.
If a builder makes a lot of reverse charge sales, it makes sense to leave the FRS on 28 February 2021, and revert to normal VAT accounting. Input tax can then be claimed on expenses such as materials, tools and overheads. A FRS user can only claim input tax on capital goods costing more than £2,000 including VAT.
Many advisers think that a business can only leave the FRS at the end of a VAT period. This is incorrect – a business can leave at any time it wants, including part way through a month. This means 28 February 2021 will be a logical exit date for many builders, the day before the new reverse charge rules take effect.
HMRC must be notified of the decision to leave the FRS by letter.
VAT saving tip on stock
There is a potential input tax windfall when a business leaves the FRS. It applies if a business has increased its total stock between the dates of joining and leaving the scheme.
When Bob the builder joined the FRS on 1 January 2015, his stock of building materials was £5,000 excluding VAT. He had claimed input tax of £1,000 before he joined the scheme.
Bob has decided to leave the FRS on 28 February 2021, his total stock is now £9,000 including VAT. He didn’t claim input tax on these materials because of the scheme restrictions. However, he can now claim extra input tax of £500 to reflect the stock increase between the joining and leaving dates. The windfall will be included on the first VAT return that is completed after leaving the scheme.
£9,000 inclusive of VAT = £1,500 VAT, less £1,000 VAT on opening stock = £500 to claim.
See guidance in VAT Notice 733, section 12.1.
Cash accounting scheme
A builder paying for building services has always made VAT return entries based on payment rather than invoices dates, if the business uses the VAT cash accounting scheme (CAS). That will change for any reverse charge supplies received from 1 March 2021.
The relevant VAT return entries (box 1 and box 4) will now be made on the purchase invoice or payment date, whichever comes first – usually the invoice date. This outcome will not affect cash flow because the reverse charge entries cancel each other out, so this is a procedural issue only.
Leave the scheme?
A builder that uses the CAS and sells services captured by the reverse charge can still record his sales in box 6 according to the date he is paid by his customer.
However, there is a potential cash flow gain here: if most sales are subject to the reverse charge, it makes sense for the builder to withdraw from the scheme, to accelerate input tax recovery on expenses from payment to invoice date. This is particularly worthwhile if builders take a long-time to pay their creditors or benefit from generous credit terms from suppliers.
It is important to act now in advance of 1 March 2021 with regard to the FRS. Once a VAT return has been submitted, it is not possible to ask HMRC to retrospectively allow withdrawal from the FRS.
For more information on the incoming domestic reverse charge regime, watch Domestic Reverse Charge: Prepare clients for 1st March at 9am on 15 February, where Neil Warren and Chris Methley join the Any Answers Live panel to explain how you can prepare your clients for the new change in the construction industry.