Alex Nicholson: No time to waste on construction VAT changes

Accountant Alex Nicholson warns Scottish construction firms to act now in preparation for the VAT domestic reverse charge.

Alex Nicholson

From 1 October 2019, there will be a significant change to how suppliers in the construction industry supply chain account for VAT. The changes will apply to businesses making or receiving specified services that are reported under the Construction Industry Scheme (CIS).

Why the Change?

The change in legislation is an anti-fraud measure designed to counter “missing trader” fraud – a practice where parties in the construction supply chain charge VAT to customers and then ‘disappear’ without remitting the VAT collected to HMRC.

HMRC estimate that the losses in unpaid VAT from the construction industry total around £100m per annum, and have introduced similar fraud-prevention measures in respect of supplies of mobile phones and wholesale gas and electricity in recent years with significant success.

What is a Reverse Charge?

The reverse charge will not change the VAT liability of a particular supply, but instead changes the way in which VAT is accounted for, effectively shifting the VAT accounting responsibility from supplier to recipient, who must account for output VAT on supplies received and, simultaneously, recover some/all of this to the extent allowed.

In the case of a business which is entitled to recover all the VAT it is charged, the reverse charge mechanism should not create a VAT cost, however there are many other considerations that the new measures create for businesses, which are explored briefly below. This is particularly pressing given that the introduction of the domestic reverse charge coincides with the new obligations established by Making Tax Digital for VAT.

When does the Reverse Charge Apply?

Generally, every supply in a supply chain, except those to its “end-user”,  will be subject to the reverse charge where the supplies involve work to the fabric of a building including; site preparation, demolition and clearance, new build work, alterations, repairs, installing means of light, heat and power and clean-up works following developments (together: “specified services”).  Any goods supplied with these services will also be subject to the reverse charge, however supplies of (for example) architectural services, the delivery of materials and so on will not.  Supplies to the ‘end-user’ in a supply chain will not be subject to the reverse charge and will instead be subject to VAT at the appropriate rate.

End Users in a Supply Chain

An ‘end-user is’ a recipient of specified construction services who uses those services for any purpose other than making further supplies of specified services , and who would include, for example, someone receiving services to their own premises or a developer whose supplies are of completed properties rather than of construction services.

‘End Users’ must provide a declaration to their suppliers which clearly states their position and permits the charging of VAT, without this the reverse charge applies. This change is unusual in the VAT process, as in other situations certification is usually needed to avoid being charged VAT, not to ensure it.         

The new rules do not apply to contractors dealing directly with non-VAT registered customers and for contracts that are zero-rated such as building new dwellings.

Impact on Construction Businesses

Construction businesses will need to review every customer, supplier and contract to determine correct VAT treatment, along with changing invoicing procedures and legal documents too. Aside from the significant administrative burden this will create for construction firms of all sizes, the biggest issue will be the negative impact on cash flow for subcontractors. Materials suppliers are not included, so VAT will still have to be paid on materials purchased and claimed back through the VAT return but subcontractors will not have the use of the VAT paid to them by their customers for up to three months as they do currently.

Time to Take Action

With HMRC confirming that they will penalise non-compliance, it is crucial that any businesses who think they will be affected by these changes take advice and act now to ensure they understand the impact they will have and the obligations they create.

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