Traditionally, the value-added tax or VAT is a tax based on a percentage of the sale price; and is applied at each stage in the production and distribution chain. However, for the construction industry, that’s all changed.

CIS VAT reverse charge schemeFrom 1 March 2021, the new VAT domestic reverse charge system for building and construction services will take effect. As the name implies, it only affects jobs that building tradespeople carry out for their clients in the construction industry.
This new system aims to reduce the missing trader fraud common in the construction industry, whereby a supplier or subcontractor would invoice and charge VAT to another builder, before going missing or going into liquidation. With this reverse charge, the VAT is moved down the supply chain, making the main contractor responsible for the VAT and pay it directly to HMRC.

To aid the process, the government has published a flow chart which lists key questions that can help you determine whether a reserve charge should be applied or not if you are supplying services customers. As such your customer must have the following attributes:

  • Does the supply fall within the scope of Construction Industry Scheme (CIS)?
  • Is the supply standard-rated or reduced-rated?
  • Is your customer VAT-registered?
  • Is your customer registered for CIS?
  • You’re not an employment business supplying staff or workers
  • Your customer has confirmed that they are not an end user or an intermediary supplier?

If the answer is ‘yes’ all of these questions, then the domestic reverse charge applies, meaning when you issue an invoice to your main contractor, you don’t include VAT on your invoice. Instead, your invoice should state “Reserve charge: Customer to pay VAT to HMRC”, along with the VAT rate. This is to make it clear that the reserve charge system has been applied, and the main contractor knows what rate to declare on their return later.

If the answer is ‘no’ to any of the first four questions, then normal VAT rules apply.

Further guidance provided, explains some of the differences between ‘end users’ and ‘intermediary suppliers’.

What is the difference between an end user and an intermediary supplier?

End users are the actual consumers or final customers of a service. The reverse charge does not apply to end users.

An intermediary supplier is a CIS and VAT registered business connected or linked in some way with an end user. This connection could be through the holding of relevant interests in the land or buildings with the construction work is to take place. Landlords and tenants are an example, as are constructions services carried out within a group of companies.

Further helpful definitions

To help define the circumstances and applicable scenarios further the government provides the following additional guidelines:

When you must use the reverse charge

  • Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures including offshore installation services;
  • Constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, i.e. walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, and more;
  • 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; and
  • Services which form an integral part of, or are part of the preparation or completion of the services i.e. 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.

When you must not use the reverse charge

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

  • Drilling for, or extracting, oil or natural gas;
  • Extracting minerals 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; and
  • Installing security systems, including burglar alarms, closed circuit television and public address systems.

Some basic examples of how this works in practice

Example 1: a transaction under reserve charge

You are a subcontractor who is VAT-registered and you charge 20% VAT normally. You carry out painting and decorating work in an office block for the main contractor AB Construction Ltd. Upon completion, you invoice AB for £2,000 on paint and other materials, and £4,000 for labour. You charge £6,000 in total but no VAT. Your invoice will mention the VAT rate (20%) and the phrase ‘Reserve change: Customer to pay VAT to HMRC’.

On your VAT Return:

  • VAT on sales – suppliers must not enter output tax on sales under reverse charge. The supplier only need to enter the net value.
  • VAT on purchases (goods) – if you buy services subject to reverse charge, you must enter the VAT charges as output tax on your VAT return. Make sure you do not enter the net value of the purchase as a net sale.
  • If the services provided (expertise/labour )are  subject to reverse charge from the subcontractor, the VAT must be accounted for in your VAT return and VAT will be recovered simultaneously on the same VAT return.

Example 2: a transaction not under reverse charge

You are a subcontractor who is VAT-registered and you charge 20% VAT normally. You carry out painting and decorating work in an office block for the owner, who confirms that he is the end-user. Upon completion, you invoice the owner £6,000 for the materials and labour, plus £1,200 for VAT.

This is reported normally in your VAT return.

Important note on the cash accounting and VAT flat rate schemes

An important point to note here is that the cash accounting scheme cannot be used for supply of services that are subject to the reverse charge. The same is true for the flat rate scheme (FRS). Users of these schemes will need to consider whether it is still beneficial to their businesses to use these schemes.

This will impact likely your cash flow, so be aware

Under the old scheme, a business would charge their fee plus VAT. If the customer was a prompt payer, the charging business would have a 20% cash flow advantage from the VAT, potentially for up to 3 months. Under the new scheme, the business won’t charge VAT and therefore won’t benefit from the cash flow advantage.

If you aren’t sure, talk to Tax Agility

Prepare yourself by making sure that your accounting systems and software can deal with the reserve charge, and take time to review your contracts with other builders and suppliers.

At Tax Agility, we are also here to provide professional guidance on this issue. You can speak to our VAT specialist.