Construction businesses should ensure they are prepared for a dramatic change in the collection and charging of VAT, warns leading independent accountancy firm HWB. New arrangements designed to combat unscrupulous contractors and their handling of VAT are due to come into effect on October 1, 2019.
Under the arrangements, a supplier or subcontractor will not charge VAT on those services falling within the definition of “construction operations”. The main contractor will, instead, effectively charge the VAT to itself and recover it as Input Tax, under a process known as the VAT Domestic Reverse Charge (DRC).
Alan Rolfe, senior tax manager at HWB, warns that he expects the new rules to cause issues because consumers and VAT-registered businesses may not know about their obligations under the charge.
In simple terms this new Domestic Reverse Charge (DRC) will only apply to those services that are currently subject to VAT at the standard or reduced rate and are already reported under the Construction Industry Scheme rules.
However, unlike the Construction Industry Scheme (CIS), the VAT charge is levied on the whole contract value, not just the labour element. The affected supplies will include a wide range of services, including the construction, alteration, repair, demolition, painting and decorating, cleaning and finishing of all types of property.
If there is any reverse charge element within a supply, then the whole supply will be subject to the charge. Certain supplies remain unaffected by the DRC and for these items VAT will still be charged by the subcontractor as usual. This includes supplies to an ‘end user’, local education authority or charity, and most supplies to a business in connection with its own business premises.
If there has already been a domestic reverse charge supply on a construction site, and if both parties agree, the charge will apply to all subsequent supplies on that site between the two parties.
“In its simplest form, the new Domestic Reverse Charge will apply to the listed construction services, but in practice, contractors might find it simpler to insist that subcontractors reverse charge all services,” said Rolfe.
“The main contractors will not incur a VAT burden as the amount incurred under the reverse charge will be fully recoverable, as their onward supplies will be taxable under the zero, reduced or standard rate.”
Rolfe warned that there were three main drawbacks to the new system.
- Firstly, the contractor and subcontractor need to determine and agree the appropriate VAT treatment for each supply.
- Secondly, the subcontractor will likely suffer a significant cashflow disadvantage from receiving only net of VAT payments under the DRC.
- Finally, there may be a significant administrative overhead in implementing the new procedures.
He added: “HMRC policy states that it will be the end user’s responsibility to declare that they are an “end user” in writing and if they don’t, they will still be responsible for accounting for the reverse charge.
“Practically, this may cause issues because consumers or VAT registered businesses are unlikely to know about their obligations under the charge.”