Reverse charge: don't sit back

HMRC has announced that the VAT “reverse charge” for building and construction services, due to be implemented from 1 October 2019, will be delayed by 12 months to 1 October 2020. Taxpayers are being urged to use this much needed delay wisely, to ensure they are properly prepared for the changes. It is expected that HMRC will have a lower tolerance for breaches given the extra time being given to businesses to get their house in order.

How does it work?

The VAT reverse charge is a significant change to how VAT is paid. Where it applies, the customer receiving the supply of construction services will be responsible for paying the VAT directly to HMRC instead of to the supplier, as it does currently.

It is designed to combat VAT fraud in the building and construction sector by preventing the supplier from charging what purports to be VAT on their services and then failing to pay this to HMRC. However, it requires considerable administrative preparation by suppliers and customers, and could result in potential cash flow issues for smaller suppliers.

The reverse charge is linked to the Construction Industry Scheme (CIS) and will only apply to payments that are required to be reported through the CIS. The CIS is another mechanism introduced by HMRC to prevent tax fraud. It involves amounts being deducted from payments made by a contractor to a subcontractor which relate to construction work and are treated as advance payments towards the subcontractor’s tax and national insurance liability.

The definition of construction services falling under the CIS, and therefore those services that the reverse charge will apply to, is very wide. It includes everything from the construction to the demolition and dismantling of buildings, structures and infrastructure. However, specific supplies are excluded from the reverse charge. These are supplies of construction services made to end users; between group companies; and between landlords and tenants.

Despite these exclusions, customers should be aware that their status under the reverse charge legislation could change throughout the supply, for example if they decide to continue to supply construction services and are no longer deemed an end user. Additionally, if only certain elements of construction services supplied are subject to the reverse charge, HMRC will treat the whole supply as falling under the reverse charge.

Implications

The VAT reverse charge will have a significant impact on customers and suppliers in the construction industry. Businesses’ current VAT systems and processes will need to be amended, and there will also be an impact on cash flow management for the affected businesses, particularly smaller subcontractors. These smaller businesses might currently rely on the positive cash flow received as a result of VAT payments to them. This will disappear as a result of the reverse charge and that, as well as causing these cash flow difficulties, could also result in disruption to the supply chain of larger contractors.

While the reverse charge is welcomed as an effective way of combating VAT fraud in the construction industry, suppliers and customers should be prepared for the significant administration and cash flow implications.

Postponed implementation

The 12-month delay to the implementation of the reverse charge was due to lobbying by certain affected bodies, and concerns that many construction businesses were not prepared to implement the changes.

While the delay is welcome, HMRC has warned that it will use the extra year to focus additional resource on identifying and tackling existing perpetrators of fraud. This means that construction companies cannot sit back for a year, and should continue to ensure that they have policies in place to ensure that their suppliers and customers are tax compliant.

HMRC is aware that some businesses will already have changed their invoices to comply with the reverse charge. Where this is the case, HMRC is prepared to take into account “genuine errors” caused by the delayed implementation of the legislation.