If you are a VAT registered CIS (Construction Industry Scheme) contractor or subcontractor, the way you deal with VAT is changing from 1 October 2019. Under the new rules, you will not charge VAT to your customers, therefore will not receive payment of the VAT, and will not pay the VAT to HMRC. It will be your customer who pays the VAT due on your invoice to HMRC on their VAT Return. The customer will be eligible to claim the VAT back under the normal input tax and partial exemption rules. This is called the “reverse charge” as the customer accounts for the VAT on the sale on behalf of the supplier.
When the “reverse charge” will apply
Unless your customer is the end user*, if you answer “Yes” to all the following questions, then the new rules will apply:
- Does the supply fall within the scope of CIS?
- Is the supply standard (20%) or reduced (5%) rated?
- Is your customer VAT registered? (You must check this!)
- Is your customer registered for CIS? (You should check this by verifying them)
*The end user is the final customer, or a customer who is registered for VAT and CIS but who will not make an onward supply of the building and construction services in question. For example: a firm of solicitors (as they are not registered for CIS) or a building contractor having work done on their own premises (as they are not making an onward supply of the services).
If you answer “No” to any of the above, the usual VAT rules will apply and you will charge VAT to your customer as normal.
Verifying the status of customers and suppliers
Suppliers may be unaware if they are supplying an end user and as a result, it is up to the end user to make the supplier aware that they are an end user and that VAT should be charged in the normal way instead of being reverse charged. HMRC have suggested that end users use the following wording on declarations made to their suppliers: “We are an end user for the purposes of section 55A VAT Act 1994 – reverse charge for building and construction services. Please issue us with a normal VAT invoice, with VAT charged at the appropriate rate. We will not account for the reverse charge.”
We would recommend that any declarations received from end users are done so in writing (or by email) and kept on file. In the absence of confirmation of end user status, the customer will be responsible for accounting for the reverse charge.
As end users are probably not in the construction industry they may not be familiar with the new rules and might be surprised to receive an invoice from you detailing the reverse charge and not charging them VAT! We would recommend that if you are dealing with a customer who you think may be an end user, you discuss this with them prior to raising your invoice – this gives them time to provide you with the relevant declaration of end user status so that you know to charge them VAT in the correct way.
Even though CIS deductions do not apply to materials, where the reverse charge applies it applies to the whole service including materials.
HMRC have put in place some simplification measures with regards to mixed supplies as follows:
- If there is an element in a supply that is subject to the reverse charge, then the whole supply will be subject to the reverse charge (for example supply and fix works)
- If there has already been a supply on a construction site that has been subject to the reverse charge then, provided both parties agree, any subsequent supplies on that site between the same parties can be treated as the reverse charge applying
If there is any doubt, provided the recipient is VAT registered and the payments are subject to CIS, HMRC recommend that the reverse charge is applied.
How to complete your VAT Return
A supplier of reverse charge services will simply include the net value of the supply in Box 6 of the VAT Return and nothing in Box 1. The customer will account for VAT in both Boxes 1 and 4 (subject to the normal rules) and the net in Box 7.
The Cash Accounting Scheme does not apply to reverse charge services, meaning you should account for VAT either on the date of your supplier’s invoice or the date of payment, whichever is earlier.
There are specific rules and transitional arrangements for self-billing invoices and single payment contracts, which are detailed in HMRC’s guidance (link at the bottom of this blog).
Accounting software and invoicing requirements
If you use Sage Accounts to prepare your VAT returns then you will account for standard rated VAT reverse charge sales and purchase invoices by posting them as tax code T20 with no VAT. Sage will calculate the standard rate VAT of 20% on these and include the VAT (for purchases) and net amounts in the relevant boxes on the VAT return. If you are partially exempt for VAT you must restrict the amount of input VAT claimed in the normal way.
If you prepare sales invoices on Sage using one of the standard invoice layouts, by using tax code T20 it should automatically include the required wording about the reverse charge on the invoice. If you use a custom invoice layout you will need to ensure wording such as: “Reverse charge: section 55A VAT Act 1994 applies – VAT payable by customer £XXX” is shown on the invoice. The VAT that would be due on the invoice must not be shown as VAT in the Net/VAT/Gross section of the invoice – this must have zero as the VAT.
The first time you prepare a VAT return which incorporates the changes it is worth checking that Sage has treated the transactions correctly!
There is no functionality currently within Xero to deal with these changes, however we expect it to be updated soon and well in advance of the rules coming in on 1 October 2019.
If you use alternative software, please contact your software provider to discuss how to record the relevant transactions.
When raising credit notes for supplies under the reverse charge, you will include the VAT amount as wording only (not as VAT) in the same way as when raising the invoice, such as “Reverse charge: customer to account for the output tax adjustment of £XXX to HMRC”.
Cashflow impact of the changes
As a supplier, if most of your services are subject to the reverse charge (or are at 0% VAT generally) and you are incurring significant amounts of input VAT on expenditure, you could be in a position where you are getting a refund every time you submit a VAT return. As a result you may want to consider submitting monthly VAT Returns. This should speed up repayments of VAT from HMRC and minimise the cashflow impact on the business. You will need to consider whether the cashflow benefit to your business outweighs the additional work involved.
If you currently use “cash basis” for VAT, paying over the VAT on your inputs only when paid rather than at the point of invoice then there will be further changes for you. The benefit of “cash basis” is that you delay the payment of output VAT until you have been paid by your customer, however as you aren’t paying over output VAT on your sales all this does is delay when you can claim back any input VAT on your purchases, so the benefit of “cash basis” disappears.
You will still use the “cash basis” for supplies you make that aren’t under the reverse charge, but where you are wholly or mainly supplying services covered under the reverse charge, it will be beneficial for cashflow for you to change to invoice basis as this allowd you to reclaim input VAT earlier. The transitional rules for switching schemes are complex and must be done with care – please get in touch if this is something you wish to do so we can guide you through making the changes in your software.
Flat Rate VAT and the changes
The Flat Rate scheme doesn’t apply to supplies covered under the new reverse charge rules – they will be dealt with in the same way as a supplier who does not use the Flat Rate scheme. As a result, if most or all of your services are going to be covered under the reverse charge then any savings that would previously have been achieved by being on the Flat Rate scheme will disappear and could actually start to be costly, even if you don’t incur much input VAT on your expenses. For many subcontractors it will be beneficial to leave the Flat Rate scheme – this does mean increased administrative work for your VAT returns as you will need to record your input VAT to reclaim it on each VAT return, however it could save you a lot of money!
Now that you know what the changes are, here’s what we recommend you do:
- Determine whether any/all of your sales will be covered by the reverse charge
- Contact regular customers to confirm “end user” status, if applicable
- Update and test sales invoice templates for the relevant reverse charge wording
- Determine whether any of your purchases will be covered by the reverse charge
- Contact regular suppliers to make them aware of the changes, in case they aren’t already
- Test tax rates/codes within your software to check they correctly treat transactions on the VAT return
- Set default tax rates/codes for your customers and suppliers, if available in your software
- Train your team – anyone involved in sales or purchases needs to be aware of the changes
- Consider the cashflow impact on your business, especially if you are on the “cash basis”, and whether to switch to monthly VAT returns
- Consider whether to leave the “flat rate scheme”, if you use it
Clearly this is significant change for construction businesses. HMRC acknowledge this and as long as you are trying to comply with the new legislation and have acted in good faith, they will apply a “light touch” to errors made in the first 6 months.
If you have any queries on the technical detail, the logistics of implementing the changes or any other impact on your business, then please get in touch.
If this affects you, we suggest that you read HMRC’s guidance note on the changes which can be found at https://www.gov.uk/guidance/vat-domestic-reverse-charge-for-building-and-construction-services
Please get in touch if you wish to discuss any aspects of this further 0116 2423400 or email@example.com
Katie Kettle, Technical Manager