It will be important for businesses to understand the Reverse Charge when it comes into effect from 1 March 2021.
An overview of when the Reverse Charge applies can be found on our website here.
A summary of the potential problems that a business might face in consequence of the Reverse Charge is set out below.
1. Cash flow
Some contracting businesses use the VAT payments that they receive from their customers as a means to pay for the materials that they buy.
Prior to the introduction of the Reverse Charge, VAT has been charged to a customer and paid to the supplier but, in some instances, it does not actually need to be paid by that supplier to HMRC until several months later, when the contracting business’s VAT return becomes due.
The Reverse Charge will now mean that the business’s customer will account for the VAT on its own VAT return and so will only pay the net value of the supply to the contractor.
Businesses in these circumstances should consider whether the loss of VAT payments to them will cause cash flow difficulties. If so, then different sources of funding may need to be considered.
2. Change in accounting procedures/software
For businesses supplying Construction Services, an invoice will need to be issued.
The invoice will either need to show how much VAT is due or the rate of VAT in respect of the services. It should also contain a legend stating that the Reverse Charge is due. Examples of the phraseology that can be used can be found here.
The accounting system of the supplier of the services will need to be able to differentiate between those sales on which VAT will be accounted for by customers as a Reverse Charge and those sales where VAT is due in the traditional way (perhaps because the supply is to an End User).
Businesses that receive Construction Services on which the Reverse Charge is due will need to update their accounting systems, so that the VAT due is accounted for on their VAT returns.
Details of how software packages can help can be found here.
3. VAT liability, staff awareness and pitfalls
The VAT treatment of building services has always been complex.
This is because, depending on the nature of the works, the supply can be either zero-rated (if this the case the Reverse Charge will not apply), subject to the lower (five per cent) rate of VAT or is standard rated (20 per cent).
The VAT liability will inform the invoice that needs to be raised by the sub-contractor and the Reverse Charge that will be applied by the contractor.
Staff or business owners entering invoices onto an accounting package will need to be aware of when the Reverse Charge applies.
The construction industry can be conservative, with businesses often choosing to charge VAT when in doubt as the safest option.
However, where VAT is incorrectly charged it cannot be recovered as Input Tax.
Though HMRC may well take a soft approach to begin with, in theory, they could raise an assessment and apply penalties where VAT has been recovered on a supply to which the Reverse Charge has been applied.
It will, however, still be a ‘debt to the Crown’ allowing them to collect the VAT from the supplier. Both the suppliers and recipient of Construction Services will, therefore, need to become familiar with the new rules.
4. Technical issues
As stated, the VAT Liability of Construction Services can be complex.
Further complexity may arise in determining whether a business’s customer is an End User.
In general, members of the public and developers will be End Users. However, some larger customers such as local authorities may not consider themselves End Users.
There may also be instances when supplies are made to a Group of Companies. If a business has any doubts about the application of the Reverse Charge further advice should be sought.
Contact our specialist VAT team on firstname.lastname@example.org if you need advice on complex VAT issues.