After two false starts due to perceived business readiness issues and COVID-19, the new reverse charge rules for the construction industry came into effect from 1 March 2021.

The domestic reverse charge rules have been designed to compliment the existing Construction Industry Scheme (“CIS”) rules and to serve as an anti-fraud measure in the construction industry in order to deny sub-contractors the opportunity to collect VAT and then ultimately not pay that VAT over to HMRC.

The relevant legislation is contained within section 55A of VATA 1994, and in the Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) Order 2019.

How does the domestic reverse charge work?

Where the domestic reverse charge applies, instead of charging VAT on their invoice to the main-contractor, the sub-contractor should not charge VAT, and the main-contractor should self-account for the VAT on behalf of the sub-contractor on their own VAT return. For the main-contractor, this would constitute an output VAT entry in box 1 of the VAT return, and where the main-contractor is entitled to full input VAT recovery, a corresponding credit may be claimed in box 4. A further entry in box 7 (net purchases) is also required by the main-contractor. The sub-contractor’s VAT reporting requirements requires them to enter the net value of the supply in box 6 of their VAT return (net sales). In light of the forthcoming MTD “digital linkage” requirements which must be satisfied from 1 April 2021, it will be particularly important to ensure that these transactions are correctly captured by the accounting system so that they pull into the correct VAT return boxes.

When must the domestic reverse charge be considered and what supplies are covered?

The domestic reverse charge should be applied in the following situations:

• The customer and supplier are registered for the CIS;
• The customer and supplier are registered, or required to be registered, for VAT;
• The customer is not an “end user” or “intermediary supplier”; and
• The supply is liable to the standard or reduced rate of VAT.

Unlike the CIS, where the domestic reverse charge applies, it applies to the provision of services and materials. Therefore because the domestic reverse charge will create a cash flow problem for many sub-contractors, some sub-contractors may seek to split their invoices with a view to charging VAT on materials supplied and invoiced separately. However HMRC, in their technical guide, have already blocked that approach confirming that, for VAT purposes, “supply and fix works will be subject to the reverse charge because the services and goods are part of one supply for VAT purposes”.

End users/intermediary suppliers’ exclusions

As the domestic reverse charge is designed to apply to services provided by sub-contractors to main-contractors, it should not apply to end users or intermediaries. For the purposes of the legislation, an “end user” is a final customer that does not make onward supplies of the building and construction services supplied to them.

An “intermediary supplier” is a business that is connected or linked to the end user. In order to be an intermediary supplier, they must either:

• Have a relevant interest in the same land where the construction works are taking place; or
• Be part of the same corporate group or undertaking as defined by section 1161 of Companies Act 2006.

Other common exclusions

Employment business

It is common for labouring staff to be provided by employment businesses. In this instance, there is a supply of staff, as opposed to construction services, which should be subject to the normal VAT rules.

5% disregard rule

There may be situations where a sub-contractor provides construction services to a main-contractor that relate to (a) the main-contractor’s own property and (b) the main-contractor’s customer’s property. In this case, in respect of the supplies at (a), the main-contractor would be the end user, and, in respect of (b), the domestic reverse charge should apply.

In this instance, the legislation provides that where the element of work subject to the domestic reverse charge amounts to 5% or less of the total value of supplies invoiced, then those supplies may be disregarded, and the domestic reverse charge should not apply.

Conclusion

It will be the responsibility of the main-contractor (customer) to notify the sub-contractor of its status in writing. In addition, as a “belt and braces” approach, HMRC also suggest that a sub-contractor may also issue a statement (such as an update to their terms and conditions) to its main-contractor to the effect of “we will assume that you are an end user, unless you notify us otherwise”. This is to pass the responsibility to the main-contractor to respond where that is not the case.

HMRC have, in their technical manual, stated that they will apply a “light touch” where errors arise within the first six months of the new legislation, provided “you are trying to comply with the new legislation and have acted in good faith”.

HMRC also confirm that their approach is that the domestic reverse charge should be the default position where there is any doubt.

Author:

Michelle Thompson

Manager – Belfast

Indirect Tax

T: 074 8342 3306

E: michelle.x.thompson@pwc.com