Head of Built Environment Projects, David Vayro explores the Construction VAT Reverse Charge, outlining the five key issues this could cause for suppliers and how to mitigate these.
What is the Construction VAT Reverse Charge?
The Construction VAT Reverse Charge (“the Reverse Charge”) is a major change in the way VAT on the supply of building and construction services across the construction sector is collected. Whether you are an occupier, developer, main contractor, specialist subcontractor or supplier to the construction sector the Reverse Charge will be relevant to you and your business to some extent.
Although it applies universally across the sector, the Reverse Charge has a greater impact on some suppliers of building and construction services than others. Operating the Reverse Charge is not automatic and so every supplier (and end user) needs to know how the system works and how to avoid the pitfalls.
Before looking at the 5 major problems the Reverse Charge can create for suppliers and end-users in the construction sector, here is a simple summary of the key facts:
- What is the Reverse Charge?
The Reverse Charge is a mechanism that shifts the burden of collection and payment of VAT on the supply of building and construction services in the UK.
- When did the Reverse Charge come into effect?
The Reverse Charge came into effect on 1 March 2021 in respect of relevant supplies from that date onwards.
- Will the Reverse Charge affect me?
The simple answer is yes if your business is concerned with the construction sector. The impact will differ depending on the parties to whom you supply construction and building services and on the parties who supply construction and building services to you.
- What will happen in the case of genuine mistakes?
The impact of this change is recognised by HMRC, and provided businesses are making every effort to comply and errors are corrected as soon as possible after identification, penalties are unlikely to be applied during the period up to the end of August 2021.
So, what are the problems which the Reverse Charge can create for suppliers and end-users of construction and building services and how can you prepare for and manage the impact of those which could affect your business?
The Pitfalls of the Domestic Reverse Charge – and how to avoid them!
Pitfall 1: Failing to prepare for the cashflow impact of the Reverse charge…
This is probably the biggest challenge facing suppliers of building and construction services. It will have a disproportionate effect on subcontractors because they will not benefit from the “End User” exception which means in simple terms that supplies to clients (as opposed to other contractors) will not be subject to the Reverse Charge.
Among Subcontractors, those who will be most significantly impacted are those who, for example, also purchase large amounts of materials from other UK VAT registered businesses. Subcontractors will no longer receive VAT payments from Main Contractors for construction services provided to those Main Contractors.
Those Subcontractors will, however, continue to pay VAT for some supplies provided by UK VAT registered businesses in their supply chain.
The significant cash flow impact is obvious. Subcontractors need to plan carefully for their changed cashflow circumstances.
Pitfall 2: Not applying the Reverse Charge to affected supplies…
The Reverse Charge does not simply have a blanket application to all suppliers of building and construction services. The obvious service such as building (including altering and extending), repairing, demolishing and dismantling buildings and structures are included, as are a wide range of infrastructure works and the installation of building services.
Cleaning (in the course of any of the above) is included as is painting and decoration and temporary works and other site infrastructure services (also in the course of the above) are also included.
More detail can be found here.
Less obviously, the Reverse Charge will also apply to plant hire services where an operator is supplied also. Where labour is supplied to fulfil a specialist construction service by a specialist subcontractor the Reverse Charge will apply, and it will also apply to the supply of materials where those materials are supplied as an integral part of any other construction service.
Failing to account for and pay VAT will, as mentioned above, be treated leniently in the first 6 months but persistent failure and evidence of no real attempt to apply the Reverse Charge correctly will have financial implications.
Pitfall 3: Applying the Reverse Charge to the wrong supplies…
The flip side of Pitfall 2 is failing properly to identify those services to which the Reverse charge does not apply. Again, a good look at the gov.uk website is essential, but in general; manufacturing services, the installation of security systems, services relating to artistic works and signwriting and the installation of signboards and advertising are not covered. Also excluded are installing seating, blinds, and shutters.
The professional services of consultants (including interior/ exterior decoration and landscaping consultants) are not subject to the Reverse Charge. Careful attention should be paid, however, to contracting arrangements (in particular Design and Build) where the architectural, structural and other design services are provided by a contractor to a party who is not an end-user. This can feature in forward-funding arrangements where the Employer/ Developer under a Design and Build Contract may not at all relevant times fall within the definition of “End User”.
Pitfall 4: Failing to make or obtain an End User declaration…
End-User declaration is a key element of the proper operation of the Reverse Charge process. End-Users will often be the “client” at the top of the contractual chain. This will often be developers (but consider complicating factors such as forward funding arrangements referred to above), the ultimate occupier of a building or structure or domestic customers.
End-Users are required to make a declaration to that effect to all contracting counterparties. This can be a more complex exercise where less common forms of contracting are adopted, such as Construction Management or Management Contracting. Under Construction Management, each of the Works Package Contractors involved in the construction of the relevant building/ structure will be entitled to regard the contractual relationship as direct with an End User, resulting in a requirement for a wider range of End User Declarations.
The position is less complex under Management Contracting with the Management Contractor (and not the works package contractors) being the party having the direct contractual relationship with the End User.
There is an equivalent duty on a contractor to obtain an End User Declaration where relevant, and so the making and/or obtaining of that declaration should be a key consideration as it impacts directly on the correct application of the Reverse Charge in any given situation.
Pitfall 5: Failing to include the correct information in invoices…
Despite the fact that a contractor may not be receiving a payment of VAT under a particular invoice, any invoice to which the Reverse Charge applies must contain all of the information required by a VAT invoice.
Importantly, where an invoice includes both items which are subject to payment of VAT in the usual way and items which are subject to the Reverse Charge, that distinction must be made clear against each relevant item.
Increasingly the providers of accounting software are updating their products with Reverse Charge options which can automate this process and the correct creation of compliant invoices. Upgrading your accounting software is probably the quickest and most effective way to avoid this particular pitfall!
We are here to help…
If you have any questions about any of the issues we have dealt with above or you want to talk to us about any other contractual issue relating to the Reverse Charge or any other aspect of your business, please call David Vayro our Head of Built Environment Projects on 07720 288850 or at firstname.lastname@example.org