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  • CIS VAT Reverse Charge

    From 1 March 2021 the domestic VAT reverse charge is a substantial change to the way VAT is collected in the building and construction industry. It must be used for most ‘VAT-able’ supplies of building and construction services.

    What are the key VAT changes?

    HMRC has been working on the reverse charge over the past few years. The aim is to tackle VAT fraud in the construction industry, specifically missing trader fraud, by making it the responsibility of the contractor or receiving sub-contractor to account to HMRC for VAT on applicable transactions.

    In other words, a contractor will no longer pay VAT over to their sub-contractor and will instead pay it directly to HMRC via their own VAT return.

    Its application will be closely linked to the Construction Industry Scheme (CIS).

    Who and What does the VAT reverse charge apply to?

    You must use the reverse charge for the following services:

    • constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services.
    • constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, including (in particular) walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours, pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence.
    • installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure.
    • internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration.
    • painting or decorating the inside or the external surfaces of any building or structure.
    • services which form an integral part of, or are part of the preparation or completion of the services described above – including site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works.

    Do not use the charge for the following services, when supplied on their own:

    • drilling for, or extracting, oil or natural gas.
    • extracting minerals (using underground or surface working) and tunnelling, boring, or construction of underground works, for this purpose.
    • manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site.
    • manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to site.
    • the professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants.
    • making, installing and repairing art works such as sculptures, murals and other items that are purely artistic signwriting and erecting, installing and repairing signboards and advertisements.
    • installing seating, blinds and shutters.
    • installing security systems, including burglar alarms, closed circuit television and public address systems.

    You should be reviewing your relationships with your suppliers and customers to see which of your trading relationships will be impacted by the reverse charge change.

    Two key things to look out for when considering where the new rules need to be applied:

    1. If the invoice is for services that fall within the CIS (both labour and materials) then the reverse charge will apply – even if the sub-contractor is not registered for the CIS.
    2. The change only applies to individuals or businesses that are registered for VAT in the UK – it will not apply to end users, consumers (individuals), if the service is zero rated or if a sub-contractor is not registered for VAT.

    There is a more exhaustive list of services impacted by the domestic reverse charge on the HMRC website. This excludes services that are excluded from the CIS.

    Once affected trading partners have been identified, businesses are advised to contact them. For contractors, this will mean notifying sub-contractors that the reverse charge will apply to services. Contractors should do this now as the change will impact the cash flow of sub-contractors, which may lead to issues on projects.

    In the absence of notification, sub-contractors should contact their customers for confirmation that the reverse charge will apply. The reverse charge should not be applied to supplies to end users and intermediary supplier businesses. End users are deemed to be consumers or final purchasers of building and construction services.

    End users may be registered for VAT and CIS, for example property developers who do not make onward supplies of building and construction services. In cases where sub-contractors are in doubt about their customer’s status as an end user, they should request confirmation in writing to determine if they need to apply the reverse charge to invoices.

    Intermediary suppliers are VAT and CIS registered businesses that are connected or linked to end users.

    If you are unsure about whether you need to apply the reverse charge, the below questions should help:

    If you sell building and construction services…

    Use this flowchart (Annex 1) to help you decide if you need to use the reverse charge. The reverse charge will need to be used when:

    • your customer is registered for VAT in the UK
    • payment for the supply is reported within the Construction Industry Scheme (CIS)
    • the services you supply are standard or reduced rated
    • you’re not an employment business supplying either staff or workers, or both
    • your customer has not given written confirmation that they’re an end user or intermediary supplier

    Annex 1: Use this flowchart to see how you would decide whether to apply normal VAT rules, or apply the domestic reverse charge. (Do not use it for services supplied by employment businesses)

    Q.1 Does the supply fall within the scope of CIS? 

    NO – Normal VAT rules apply

    YES – GO TO Q.2

    Q.2 Is the supply standard rated or reduced rated?  

    NO – Normal VAT rules apply

    YES – GO TO Q.3

    Q.3 Is your customer VAT registered?

    NO – Normal VAT rules apply

    YES – GO TO Q.4

    Q.4 Is your customer registered for CIS? 

    NO – Normal VAT rules apply

    YES – GO TO Q.5

    Q.5 Has your customer provided confirmation that it is an end user? 

    YES – Normal VAT rules apply

    NO – DOMESTIC REVERSE CHARGE APPLIES

    If you buy building and construction services…

    Use this flowchart (Annex 2) to help you decide if you need to use the reverse charge. The reverse charge will need to be used when:

    • payment for the supply is reported within the Construction Industry Scheme (CIS)
    • the supply is standard or reduced rated
    • are not hiring either staff or workers, or both
    • you’re not using the end user or intermediary exclusions

    Annex 2: This flowchart is to help businesses receiving building and construction services check whether normal VAT rules or the domestic reverse charge apply.

    Q.1 Is the supply made by an employment business?

    YES – Normal VAT rules apply

    NO – GO TO Q.2

    Q.2 Is the supply received within the scope of CIS? 

    NO – Normal VAT rules apply

    YES – GO TO Q.3

    Q.3 Is the supply standard rated or reduced rated?

    NO – Normal VAT rules apply

    YES – GO TO Q.4

    Q.4 I have confirmed with my supplier that I am an end user?

    YES – Normal VAT rules apply

    NO – DOMESTIC REVERSE CHARGE APPLIES

    What is the 5% disregard for VAT reverse charge?

    The VAT reverse charge says that certain work undertaken by a subcontractor must have the reverse charge applied if that work falls under the CIS. A general list of the work that does fall under the CIS, and the work that doesn’t, can be found on the government’s website.

    This is true if a sub-contractor invoices for a mixture of work – so called mixed invoices – of which some falls under the CIS VAT reverse charge rules, but the rest doesn’t. In this case, the VAT reverse charge should be used.

    But there’s an important exception.

    If the component of the invoice for work that falls under the CIS VAT reverse charge rules is just 5% or less of the total amount invoiced, then the normal VAT rules are applied, and the CIS VAT reverse charge isn’t used.

    For example, installing a security system does not fall under the CIS reverse charge rules. Installing lighting does. So, if an electrician were to visit a site to wire a security system and also took care of some lighting wiring while there, and the latter work represented 5% or less of the invoice amount, then the CIS VAT reverse charge should not be applied to the entire invoice. But if the lighting wiring work was 10%, for example, then the VAT reverse charge should be applied to the entire invoice.

    What practical steps will you need to take?

    From an administrative perspective, the practical changes resulting from the VAT domestic reverse charge will primarily impact the following three areas from 1 March 2021:

    • Invoicing and payment
    • VAT Returns
    • Recording transactions

    Invoicing and payment

    Contractors

    Payment to the sub-contractor will now not include VAT; as should be set out on the sub-contractor invoice. Instead, the contractor will be paying the VAT directly to HMRC via their own VAT return.

    This can still be reclaimed by the contractor in the usual manner, meaning the net impact is zero.

    Where customers issue authenticated tax receipts or self-billing invoices, HMRC recommends the following wording is added:

    “Reverse charge: We will account for and pay the output tax due to HMRC”

    “Reverse charge: As the UK customer, we will pay the VAT due to HMRC”

    Sub-contractors

    Sub-contractors will no longer need to include VAT in the amount payable on sales invoices. However, sub-contractors are still required to clearly state how much VAT is due under the reverse charge or the rate of VAT if the VAT amount cannot be shown.

    They are also required to 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.

    HMRC suggests something like the following:

    “Reverse charge: VAT Act 1994 Section 55A applies”

    “Reverse charge: S55 VATA 94 applies”

    “Reverse charge: Customer to pay VAT to HMRC”

    Where there is a CIS deduction, this should still be included on the invoice. Here is an example of the change to sub-contractor invoicing:

    Item Old Method New Method
    Sales value £1,000 £1,000
    Less: 20% CIS deduction (£200) (£200)
    VAT @ 20% £200 £0
    Net Invoice £1,000 £800

     

    Although sub-contractors are no longer collecting VAT, they are also no longer required to pay it over to HMRC, meaning that, like the contractor, the net impact is zero. However, the sub-contractor may well find that they are adversely affected from a cash flow perspective as they will no longer be holding on to this money before paying it over to HMRC – money that may be being used to support working capital.

    VAT Returns

    Contractors

    The contractor should calculate the VAT due on the purchase at the relevant rate; if this hasn’t been done by the sub-contractor. This should then be recorded as VAT on a sale and on a purchase.

    This should be recorded in boxes 1 and boxes 4 on the contractor’s VAT Return. Assuming the contractor is on the standard VAT scheme, here is an example of the changes to completing a VAT

    Return based on the above invoice:

    VAT Box entry Old Method New Method
    Box 1 – VAT due on sales £0 £200
    Box 2 – VAT due on EC acquisitions £0 £0
    Box 3 – Total VAT due £0 £200
    Box 4 – VAT reclaimed on purchases £200 £200
    Box 5 – VAT to Pay (Reclaim) to/(from) HMRC (£200) £0
    Box 6 – Total value of sales excl VAT £0 £0
    Box 7 – Total value of purchases excl VAT £1,000 £1,000
    Box 8 – Total value of EC supplies excl VAT £0 £0
    Box 9 – Total value of EC acquisitions excl VAT £0 £0


    Sub-contractors

    The sub-contractor will no longer need to record the VAT on sales when they are completing a VAT Return, so no longer need to include the value in box 1.

    Assuming the contractor is on the standard VAT scheme, here is an example of the way VAT Returns should be completed from March 2021 based on the above invoice:

    VAT Box entry Old Method New Method
    Box 1 – VAT due on sales £200 £0
    Box 2 – VAT due on EC acquisitions £0 £0
    Box 3 – Total VAT due £200 £0
    Box 4 – VAT reclaimed on purchases £0 £0
    Box 5 – VAT to Pay(Reclaim) to/(from) HMRC £200 £0
    Box 6 – Total value of sales excl VAT £1,000 £1,000
    Box 7 – Total value of purchases excl VAT £0 £0
    Box 8 – Total value of EC supplies excl VAT £0 £0
    Box 9 – Total value of EC acquisitions excl VAT £0 £0

     

    The above example focuses on a single transaction but assuming a sub-contractor’s trade is predominantly made up of sub-contracting work and the purchase of materials, they are likely to become ‘repayment traders’ whereby their VAT return is a net claim from HMRC rather than a net payment.

    What you need to know about the flat rate scheme

    One key thing to point out is that many sub-contractors who have minimal purchases and therefore minimal input tax to reclaim currently apply the flat rate scheme. This allows them to apply a fixed rate percentage to gross turnover to determine VAT due and helps to simplify the process and manage cash flow.

    However, transactions that fall within the remit of the new reverse charge should be accounted for outside of the flat rate scheme and as a result, the scheme may no longer be beneficial for the sub-contractor. While they no longer collect and pay VAT on the reverse charge transactions, they can also no longer reclaim input VAT on purchases as they would be able to under the standard scheme.

    What are the key deadlines?

    The implementation date for when the new rules will come into place is 1 March 2021. This means that, in most cases, invoices raised after this date should apply the reverse charge if applicable even if the work was carried out prior to 1 March 2021.

    HMRC has also stated a period of implementation during which it will apply a ‘light touch’ in dealing with any errors made, so long as people are trying to implement the new legislation and have acted in good faith.

    How to help your customers and suppliers with the VAT domestic reverse charge

    If you are a contractor, make sure you have contacted sub-contractors to let them know about the changes.

    Similarly, if you are a sub-contractor, you should contact customers to determine VAT treatment on sales.

    If you are an end user you should confirm this to your suppliers

    Finally, some other consequences to be aware of…

    Tip 1

    Identify those sub-contractors who are not registered for CIS (and therefore incur higher rate CIS deductions). These suppliers are likely to be less well informed of the changes and may believe the new legislation doesn’t apply to them because they’re not registered for CIS. This is not the case. If they make a supply that’s reported by the contractor under CIS then the legislation applies.

    Make sure all of your staff who are responsible for VAT accounting are aware of the reverse charge and how it will work. If you are a contractor, you should also be proactive in contacting your VAT-registered sub-contractors prior to the 1 March 2021 to ensure they are aware of these changes and do not invoice you for VAT.

    Likewise, if you are a sub-contractor, be sure to contact your contractor customers to make them aware you will be applying the domestic reverse charge to invoices from 1 March 2021.

    Tip 2

    Consider whether the change will impact your cash flow. If you are a sub-contractor then it’s likely your cash flow will be adversely impacted as you will no longer be receiving the VAT payment from your customer. If you are the contractor, you will likely have a short-term cash flow benefit as you will no longer be paying the VAT amount to the subcontractor, however you must remember you will need to account for VAT as output tax (box 1) as well as input tax (box 4), along with the rest of your VAT accounting. Remember to reach out to your accountant who will be able to help should you need it. Good quality bookkeeping software solutions should have an update to automate the VAT processing and invoice wording.

    Reverse charge transactions are excluded from the cash accounting scheme but you can remain on the scheme and continue to account for non-domestic reverse charge work on a cash accounting basis. However, if you are a sub-contractor and all of your sales will be subject to domestic reverse charge, then you may well want to stop using the scheme so that you can start to reclaim your input tax earlier on an invoice basis, rather than a cash basis.

    Tip 3

    As discussed, many sub-contractors may find they will become repayment traders. Repayment traders can apply to move to monthly returns to speed up repayment, which will help with cash flow.

    Tip 4

    If you are a sub-contractor who is operating under the flat rate scheme, then you should assess whether this is still beneficial or whether you should consider moving to the standard scheme.

    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 you are a sub-contractor and all of your sales will now be subject to domestic reverse charge then it makes sense to leave the scheme, as you will no longer have any output VAT to account for (as these supplies are excluded from the flat rate scheme turnover) and so by remaining on the flat rate scheme, you will be disadvantaged as you are still be blocked from recovering input tax on materials and overheads, etc.

    If you are main contractor supplying end users and do not make any supplies that fall under the domestic reverse charge, then your position is largely unaffected. You will continue to charge VAT as normal and include the gross value of the supply in your flat-rate turnover. If you receive supplies from sub-contractors that are subject to the domestic reverse charge, these are dealt with on the VAT return 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.

    As your accountant, we will support you through this as much as possible. However, if you require any additional support, please contact us.

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