How will the VAT domestic reverse charge for the construction industry work in my accounting software?

The way in which VAT is charged on construction services will change from 1 March 2021.

This affects VAT registered businesses who supply or receive construction services that are reported under the Construction Industry Scheme.

It means the contractor will be responsible for the VAT due to HMRC instead of the supplier (sub-contractor).  More details about when the domestic reverse charge applies can be found here.

The changes will affect how invoices are recorded in your accounting software, both for those businesses who supply construction services and for those businesses who receive construction services.

Our Business Innovation team have put together some useful guidance to help make sure your accounting software is up to speed with the changes:

SAGE50

Sage 50cloud Accounts Version 27 includes new tax codes to deal with the changes.

Two new tax codes have been created:

  • T21 is to be used where the CIS reverse charge standard rate applies
  • T26 to be used where the CIS reverse charge reduced rate applies

To ensure the VAT return is calculated correctly the above tax codes should be used.  If tax codes T21 or T26 are already in use, the next available tax code will be used by the software.

T21 and T26 can be used by both the subcontractor and the contractor and you only need to enter the net amount as the VAT calculation for the VAT return will be completed automatically.

How do the Sage tax codes work under the different VAT schemes?

Standard VAT

  • When a sub-contractor uses tax code T21 or T26 on an invoice for their contractor, Box 6 of the VAT Return (total value of sales excluding VAT) will be updated with the net value.
  • When a contractor uses T21 or T26 to record their purchase from the sub-contractor, the net value of the purchase affects Box 7 of the VAT Return (total value of purchases excluding VAT) and the VAT value affects Boxes 1 and 4 of the VAT Return. The VAT is paid and reclaimed on the same VAT Return.

VAT Cash Accounting

VAT Cash Accounting rules do not apply to reverse charge transactions. So where reverse charge applies and the T21 or T26 tax code is used, the values from the invoice or credit will update the VAT Return, not the payment or receipt as would usually be expected for businesses using VAT Cash Accounting.

Flat Rate VAT

Similarly, Flat Rate scheme rules do not apply to reverse charge transactions. If the sub-contractor or contractor uses the Flat Rate scheme, they should account for reverse charge transactions outside of the scheme using tax code T21 or T26.

Invoices and credit notes

If the T21 or T26 tax code is used, then the invoice or credit note produced in Sage 50cloud Accounts includes the following text:

  • Invoice text – ‘Customer to pay output tax of £X to HMRC’
  • Credit note text – ‘Customer to account for output tax of -£X to HMRC’

XERO

Xero now includes four new tax rates to deal with the changes, as follows:

  • 20 per cent VAT on Income
  • 5 per cent on VAT Income
  • 20 per cent VAT Expenses
  • 5 per cent VAT on Expenses

You will need to add the new reverse charge tax rates into your Xero organisation.  This can be done by:

1. Going to the Accounting menu, then select Advanced

2. Click Tax rates

3. Click Add Domestic Reverse Charge Tax Rates

4. Click Add Domestic Reverse Charge Tax Rates to confirm

Using the new tax rates will have the following impact on the VAT return:

For suppliers

Under the new rules, suppliers that provide a construction service do not account for the VAT due on the supply.

When completing the VAT return, Xero will automatically:

  • Enter the total value of the sales subject to the reverse charge (including credit notes) in Box 6 of the return as normal.
  • Not record any sales tax in Box 1, as this is now accounted for by the contractor.

For customers

Customers receiving a construction service account for the VAT on sales, by selecting a domestic reverse charge tax rate on the invoice. The VAT on sales gets deducted as an input in the VAT return, which means no net tax is payable to HMRC.

When completing the VAT return, Xero will automatically:

  • Enter the tax on purchases subject to the domestic reverse charge, including any reductions due to credit notes, in Box 1 of the return.
  • Reclaim the input tax on the domestic reverse charge purchases in Box 4, subject to the normal rules. This includes any reductions due to credit notes.
  • Enter the net value of the purchases under the domestic reverse charge (including credit notes) in Box 7.

QUICKBOOKS ONLINE

From 1st March 2021 there will be 2 new VAT codes that can be used to account for the VAT reverse charge within QuickBooks Online, one for 20% and one for 5%.  Once the VAT code has been selected and applied to the invoice the software will automatically account for the reverse charge and the VAT will be reflected on the VAT return.  There will be no need to do any further adjustments on your VAT return for the reverse charge.

If you already have VAT and CIS enabled within your QuickBooks Online product then you will not need to set up anything else.  If VAT and CIS have not been enabled, you must enable them within the software before you can use the new reverse charge codes.

If you need any assistance with any of the above, please contact Lyndsay Hardwick or our Business Innovation team by emailing bi@milstedlangdon.co.uk.

Posted in Reverse Charge.