Last week, HMRC announced a further delay to the introduction of the domestic reverse charge for construction services for a period of 5 months, until 1 March 2021.
Originally planned to begin on 1 October 2019, we wrote this blog before HMRC’s announcement in response to many of our clients asking us what it is and how it will affect their business, over the past few months.
Reading this now, post-HMRC’s announcement about delaying it, this may seem a bit premature. However, it pays to be prepared, so we’re sticking to our original blog below, looking at who the VAT domestic reverse charge will affect, how it works, how you can prepare for it and how you need to account for the VAT on your invoices.
So, what is the VAT domestic reverse charge and who will it affect?
From 1 March 2021, HMRC is changing the way that VAT is charged for construction and building services in an attempt to prevent VAT evasion.
At the moment, if a construction project involves a contractor and a subcontractor and they are both VAT registered, the subcontractor raises an invoice with VAT and sends it to the contractor. The contractor pays all of this invoice, so the subcontractor gets paid the total amount including the VAT.
Come March 2021, this will change. The invoice raised by the subcontractor will still have VAT on it, but it will be at the domestic reverse charge rate of 0%. The contractor, when receiving that invoice, then adds the VAT before sending it to the end client, so the VAT is never received by the subcontractor. In that quarter, the contractor will pay the VAT and claim it back on their own VAT return.
The new domestic reverse charge is only applicable if there is a contractor, a subcontractor and an end client involved in a construction project. If there is no subcontractor and it’s just the contractor and end client involved, the contractor would charge VAT as normal.
The supply of services from architects, surveyors and consultants, the provision of building materials, and things like security systems, window cleaning, blinds and seating are exempt, unless they are delivered as part of a larger package of services, in which case the new VAT reverse charge rules apply.
How will the VAT domestic reverse charge impact my business?
For those subcontractors who manage their cashflow effectively, this change will mean a fairly straightforward admin task to ensure that invoices are updated to include the new VAT reverse charge rate. HMRC advises that invoices should still include VAT, but it should be shown at 0% with a footer stating that VAT is charged at the domestic reverse charge rate.
However, it is worth noting that contractors each have their own requirements when it comes to invoicing. We have received emails over the past few months from the finance departments of large contractors stating that, unless their strict requirements are met by subcontractors when invoicing, invoices will not be paid. In this scenario, subcontractors will not be informed if their invoices are incorrect, so it will only become apparent once payments aren’t made by the contractor. At this point, corrections would need to be made to the subcontractor’s invoice so that it can be entered into the contractor’s system. With some contractors working to 90-day terms and beyond, this could lead to issues for even those subcontractors who are most diligent with their cashflow. This, at least for the first few months, will likely have a far greater impact than the VAT element.
For subcontractors who don’t have a handle on their cashflow, we do anticipate the VAT element to be more of an issue, at least in the short term, as they will no longer be paid the VAT.
How can I prepare for the VAT domestic reverse charge?
First, you need to know how the reverse charge will affect your sales, purchases or both.
If you’re a contractor, start by looking at all of your subcontractor contracts to see if the reverse charge will apply to any services you receive. Then, contact each subcontractor and let them know.
If you’re a subcontractor, you should speak to the contractors you work with to ensure you fully understand their invoicing requirements, to avoid any unnecessary delays to payments. You should also review your customer contracts to understand if the reverse charge will apply, including confirming whether your customer is an end user or intermediary supplier.
Next, make sure your accounting systems and software have been updated to handle the reverse charge. Although, at the moment many accounting software providers haven’t accommodated the change. We are told they are working on it.
If you have any questions or concerns about how this will impact you and your business, please get in touch.