HMRC has recently consulted with interested stakeholders concerning changes in VAT procedures that will affect contractors and their sub-contractors in the construction industry. Nick McChesney - our VAT partner and a member of a working group that is liaising with HMRC on the proposals - looks at the potential impact of the new rules on the sector.
What is the issue?
The proposed changes affect the way VAT is accounted for on supplies of construction services between sub-contractors and contractors.
Under existing VAT accounting procedures, the supplier, whether it is a main contractor or a sub-contractor, invoices the VAT due on construction work to its customer. However, there is a particular risk HMRC is concerned with that a non-compliant sub-contractor may not pass on the VAT it has collected to HMRC as output tax. As a result, HMRC is consulting on a proposal to counter this risk by introducing a ‘domestic reverse charge’ for supplies of construction services to VAT registered businesses.
HMRC’s proposal is that the definition of construction services will be linked to the definition used to determine when payments have to be reported through the Income Tax (Construction Industry Scheme) Regulations, commonly referred to as the ‘CIS’. The changes will not apply to supplies of construction services to the end users of the buildings (ie those who receive construction services other than for the purposes of making an onward supply of such services).
What is a reverse charge?
Under a reverse charge system, where a customer is VAT registered, instead of the supplier invoicing the customer with the appropriate amount of VAT due, the supplier would invoice supplies of construction work without VAT. This minimises the risk of fraudulent evasion of VAT. Instead, the customer will be required to account for the VAT due on the supply to HMRC on its VAT return at the tax point. The customer will also be entitled to reclaim the VAT on the supply as input tax, subject to the normal VAT rules. Hence, there will be no net overall effect in terms of VAT liability for a customer who is entitled to a full VAT recovery.
How am I likely to be affected?
If implemented, the change is likely to come into effect in October 2019.
The proposed changes are likely to cause administrative headaches for suppliers and customers when they come into effect. They will require all affected supplies to be identified and accounted for correctly once the new rules come into effect.
Changes will have to be made to accounting software and systems to deal with the new rules and these will need to be planned well in advance.
Both parties to a construction contract will need to be clear on whether the service is one to which the CIS applies (and thus subject to the reverse charge) or whether the supply is one of the ‘excepted supplies’, such as a supply to an end user of the services. VAT will continue to be due under current rules on these supplies.
The supplier must determine whether its customer is VAT registered and when VAT has to be charged. Customers will also need controls to ensure that the correct VAT treatment has been applied to applications for payment or invoices raised by their supplier. Technically, VAT will only be deductible as input tax when it is correctly invoiced by the supplier. Where VAT is not charged by the supplier, the customer will still have to determine the correct amount of VAT chargeable on the supply and to record this in its VAT returns in accordance with the reverse charge rules.
There will be a significant change to the cashflow position of both the supplier and customer that will need to be considered.
What should I do now?
The proposed changes are still at the consultation phase. However, we understand that there is a strong possibility that the new rules will be brought into law to counter the fraudulent activity in the sector. Please get in touch with Nick McChesney on email@example.com or + 44(0)20 7516 2262 to find out more about how the proposals could affect your business or accounting systems.