Building a better VAT system, in reverse

First published on 24 February 2021 by Alastair
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If you work in the Construction Industry, you’ll already know that under the Construction Industry Scheme (CIS), contractors deduct money from subcontractors’ payments and pass it to HMRC, with these deductions then counting as advance payments towards the subcontractor’s tax and National Insurance.  You’ll also know that contractors must register for the scheme but subcontractors don’t have to – although if they’re not registered deductions are taken from their payments at a higher rate.

You’ll also know that from 1st March this year, there is a change in the way VAT is handled and paid by CIS registered businesses.  This new scheme – the domestic reverse charge (DRC) scheme – is causing some concern for a number of clients. This is partly because no-one likes doing their VAT (even HMRC tax advisers who don’t specialise in VAT struggle) and also because no-one likes change.  Still, it’s here, so we need to understand it…

What is domestic reverse charge VAT?

Essentially, it is a change in the way CIS registered construction businesses handle and pay VAT. More specifically it’s an anti-fraud measure which is intended to counter sophisticated criminal attacks on the UK VAT system, cutting down on “missing trader” fraud. This is where companies receive high net amounts of VAT from their customers but then don’t pay the VAT to HMRC.

What does it mean?

All VAT registered CIS contractor businesses will now be responsible for the VAT due to HMRC instead of the subcontractor.  It will apply to most supplies of building and construction services and to standard and reduced-rate VAT services.

Here are a number of links that should help you get your head around the change.  As always, if you are unsure of anything and would like some help, please don’t hesitate to contact us.

CIS scheme (general background)

Government guide to DRC

XERO (accounting software) guide

FreeAgent (accounting software) guide

 

Finally, here is a very useful Q&A, available freely elsewhere online.

Q. My client owns some land and intends to appoint a main contractor to build new commercial premises, which the client will then sell – will my client have to apply the domestic reverse charge to the invoices received?
A. No, as your client is a developer (landowner) and will be selling a completed building, not supplying on construction services, they will be classed as an end user, and therefore the contractor will charge vat on their invoice as normal.

Q. My client acts both as a main contractor and a sub-contractor. How do they record supplies made and received on their VAT return, and what should their invoices look like?
A. Supplies made – your client should still show all of the information normally required on a VAT invoice, make a note on the invoice to make it clear that the domestic reverse charge applies and that the customer is required to account for the VAT.

It should also clearly state how much VAT is due under the reverse charge, or the rate of VAT if the VAT amount cannot be shown, but the VAT should not be included in the amount charged to the customer.

The client should record the sale in Box 6 only on their VAT return.

Supplies received – for domestic reverse charge invoices received, these need to show in the following boxes on the VAT return:

Box 1 – VAT amount shown on the invoice to be paid to HMRC;

Box 4 – VAT amount to be recovered subject to normal input tax rules;

Box 7 – Net value of the invoice as a purchase.

Q. My client is a construction business and has CIS gross payment status, so does this mean that because there are no CIS deductions on the invoices they issue, the supply of construction services does not fall under the construction domestic reverse charge?
A. This is not the case – even where a supply is made by or to a construction business that has CIS gross payment status, the supplies are still within the CIS reporting requirements and therefore would still be subject to the domestic reverse charge.

Q. My client acts both as a sub-contractor and main contractor, and uses the cash accounting scheme. HMRC’s guide says that you cannot use the VAT cash accounting scheme for supplies of services that are subject to the reverse charge. Does this mean they need to stop using the scheme altogether?
A. Not necessarily – reverse charge transactions are excluded from the cash accounting scheme but your client can remain on the scheme and continue to account for non-domestic reverse charge work on a cash accounting basis. However, if your client acts as a sub-contractor and all of their sales will be subject to domestic reverse charge, then they may well want to stop using the scheme so that they can start to reclaim their input tax earlier on an invoice basis, rather than a cash basis.

Q. I have heard my client needs to leave the flat rate scheme because of the domestic reverse charge – is this true?
A. Again, that is not necessarily the case. Supplies made and received under the domestic reverse charge should be dealt with completely outside of the flat rate scheme. As in the previous question if the client acts as a sub-contractor and all of their sales will now be subject to domestic reverse charge then it makes sense to leave the scheme, as they will no longer have any output VAT to account for (as these supplies are excluded from the flat rate scheme turnover). By remaining on the flat rate scheme, they will still be blocked from recovering input tax on materials and overheads, etc.

If the client is a main contractor supplying end users and does not make any supplies that fall under the domestic reverse charge, then their position is largely unaffected. They will continue to charge VAT as normal, and include the gross value of the supply in their flat rate turnover.

If they receive supplies from sub-contractors that are subject to the domestic reverse charge, these are dealt with on the VAT return as described above, and the Box 4 input tax can be claimed in line with normal input tax rules, as the reverse charge is dealt with outside the flat rate scheme altogether.

Stewart McKinnon, Director

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