As of 1 October 2020, a shake-up of VAT rules within the construction sector is set to affect more than 150,000 SMEs covered by the Construction Industry Scheme (CIS).
For a long time, small and medium-sized businesses within the construction industry have been in charge of administering their own VAT, adding the tax owed to the final bill that they send their customers and using this money as working capital until it is time to complete and pay their tax return.
However, HMRC have launched a crackdown on tax avoidance over the past few years, and in their investigation have unearthed a pattern of tax avoidance connected with paying VAT in this way.
These suppliers, or ‘subcontractors’ will charge the main contractors VAT but then disappear before it is time to pay the tax to HMRC. After a business name or address change, many of them have been getting away with this for years, which is what the changes aim to tackle.
What are the VAT changes?
From 1 October 2020, VAT cash will no longer be passed between businesses in the construction industry.
For contractors and sub-contractors registered under the CIS, when supplying construction services, the contractor no longer has to account for VAT on their final bill. Instead, the customer will make a note of the tax owed and pay it as part of their own tax bill. Essentially, this will work as if the customer has supplied themselves with the service.
Sub-contractors will now rely on the company which employs them to work out and pay the VAT owed on the service they provided. The tax bill will take into account both the service supplied and the cost of the materials used.
This process will be known as the domestic reverse charge (DRC)
How to apply the reverse charge
Although it may sound complicated, the reverse charge is actually very simple and cuts out a lot of steps that could have made the tax process more complicated for sub-contractors in the past.
As of October, any business providing construction-related services to another business will put on their invoice that the service provided is subject to the DRC. On receipt of the invoice, the customer will account for the VAT owed and add it to their own accounts, so that they can pay it direct to HMRC when it comes time to file their tax return.
The tax is charged at the normal rate (which is 5% or 20% depending on the business), and is tax neutral, meaning that although the sub-contractor is prevented from claiming tax expenses and not passing it on, there is no actual tax burden on either party.
Who is affected by the changes?
These tax changes only affect those in the construction industry, and those who supply construction services to main contractors. This will include:
- VAT-registered businesses or individuals in the UK, who sell to other VAT-registered companies
- Those who are CIS-registered and provide services listed under CIS.
- Businesses involved in groundworks or other preparatory works.
- Those involved in construction alterations or building repair.
- Those who install heat, light or power systems.
- Internal and external painting and decorating.
Supplies of services that are excluded from the DRC include:
- Construction services supplied to end users. This would be businesses who report their payments for certain supplies and services through CIS but do not actually provide construction services themselves.
- Construction services supplied between group companies.
- Construction services supplied between landlords and tenants.
- Support services including surveying, machinery, architecture and consulting, installation of security systems and drilling or extraction services.
What should those affected do now?
If you believe that your business is affected by the domestic reverse charge, whether you are a contractor or a sub-contractor, it is essential that you get your business in order sooner rather than later to avoid penalty. Some steps that you should take are:
Review your current business relationships
Take some time to look through the businesses you currently work with as part of the construction service supply chain, to work out how the reverse charge will affect your company.
Depending on where you are in the chain with your various suppliers and customers, this may affect your sales, your purchases or both. Get yourself up to date and then pass on this information to your clients so that everyone is ready in time for the change to come into force.
Set up new systems
Get new systems in place so that you are ready to send reverse charge VAT invoices, or account for VAT and then report this accurately to HMRC, depending on whether you are a contractor, sub-contractor or both.
Keep accurate records
As a business you should already be keeping good, accurate records but, with HMRC looking closely at these processes at the moment, now is the time to tighten up your accounts if possible. Take some time to get all of your accounts up to date and easy to read, so that you can easily look at them and make sure that sub-contractors are not sending you VAT-inclusive invoices instead of reverse charge invoices.
If you work as a sub-contractor, you need to make sure that you know who is affected by the changes in your supply chain, so that you can start sending them reverse charge invoices as opposed to VAT-inclusive ones. Getting your accounts in order so that all of these issues are clearly noted and taken care of can make this time more relaxed for you.
Be prepared for temporary cash flow changes
VAT changes can impact your cash flow whether you are a contractor or a sub-contractor. For sub-contractors, not receiving VAT from customers will temporarily reduce the amount of working capital you have to hand, so it is worth looking at solutions to briefly ease the impact of this.
Although the changes shouldn’t really affect contractors, the fact that it is likely to affect suppliers may have a knock-on effect. Getting prepared and staying in contact with everyone affected can help businesses to keep their finances looking healthy during the changeover period.
Talk to an expert
If you would like to talk to your accounting partner at Numerion about the changes to VAT for the construction industry, please call us on 020 3948 4108 or send us an email.