From 1 October 2019 significant changes are being introduced to the VAT treatment of supplies in the construction industry. A domestic “reverse charge” rule is being introduced which will change the person responsible for accounting for VAT on to certain supplies of construction services. In particular, supplies between sub-contractors and main contractors will be impacted by the changes.

The Government has recently published a final version of the draft legislation which will introduce the changes.

Why are HMRC introducing changes?

HMRC are concerned about the current levels of Missing Trader Fraud. This involves a supplier issuing a VAT invoice and collecting VAT from their customer before going “missing” and not declaring the VAT to HMRC. Requiring the customer to account for the VAT removes this risk. There is an estimated £100m tax loss due to this type of fraudulent activity.

What are the VAT changes?

Currently, a sub-contractor is responsible for charging and accounting for VAT to HMRC on supplies to main contractors. From 1 October 2019, the main contractor will be responsible for declaring the VAT on supplies received from the sub-contractor under the “reverse charge” rules. An equivalent VAT deduction can also be claimed by the main contractor subject to the normal rules of VAT recovery.

For example, a sub-contractor is due to charge £100k on a standard rated project. Currently they would collect £20k as output tax and remit this to HMRC on their next VAT return. From October 2019 the sub-contractor will only charge and collect £100k. They will not receive the £20k VAT.

Looking at the same scenario from the contractor’s perspective, they would currently pay £120k to the sub-contractor, and then reclaim the £20k of input tax on their next VAT return. From October 2019 they will now only pay £100k to the sub-contractor and will then charge themselves £20k on their next VAT return (assuming this relates to a taxable supply and there is no partial exemption).

Who is affected by these changes?

Broadly speaking, the new rules will only affect supplies at the standard or reduced rate of VAT where payments are required to be reported through the Construction Industry Scheme. The categories of construction services affected by the VAT changes will include: general construction, groundwork construction, renovations and maintenance services, HVAC, cleaning services and painting and decorating of buildings and structures. Civil engineering work is also caught.

Note that the new rules will only apply on supplies between VAT registered businesses in circumstances where the recipient makes an onward supply of construction services. This means the VAT treatment of supplies to the final customer (e.g. property owner) will not change. There are a number of other exclusions including:

• Zero-rated supplies (e.g. the construction of new dwellings)
• Certain supplies between connected companies
• Certain supplies between landlord and tenant
• Services provided by architects, surveyors and other consultants
• The manufacture of certain building or engineering equipment and components
• The installation of security systems, burglar alarms, CCTV and PA systems

The VAT treatment of services provided to the final customer should not be affected by the changes.

What should businesses in the construction industry do to prepare for the changes?

All businesses involved in the construction industry should review their supply chains to consider how they will be impacted by the changes. It will be important to identify the categories of supplies which may be subject to the new “reverse charge” rules and update accounting systems accordingly. Contracts for services between sub-contractors and contractors may need to be reviewed and updated.

Note that supplies in the construction industry can potentially be subject to VAT at 0%, 5% or 20%. Businesses which receive services from another contractor will need to determine which VAT rate applies and whether or not the services received will be subject to “reverse charge”.

1. What is the cashflow impact and what should I do to manage it?

Because VAT payments will be stripped out of the supply chain, sub-contractors which operate accrual (invoice) accounting will not benefit from holding/using a VAT payment from a customer until the due date for the submission and payment of the VAT return. VAT will disappear from working capital and cash-flows will need to adjust to reflect this.

From October 2019, many sub-contractors will be in a VAT repayment position with HMRC because of VAT incurred on materials. Businesses that submit repayment claims on VAT returns are often subject to additional verification of VAT records by HMRC which can lead to delays in receiving VAT repayments.

Sub-contractors which find they will be in a regular VAT repayment position because of the changes should consider requesting monthly VAT returns to allow quicker repayments.

2. What does this mean for my invoicing and VAT accounting procedures – what changes are required to documentation, bookkeeping and VAT returns?

The transition date from the current VAT regime is 1 October 2019. Any invoices raised, or certification provided for payment from this date is affected. Invoices/applications for payment for relevant supplies must include a reference to the fact that it is reverse-charge supply and not include VAT.

Recipients of the supply must account for VAT on the value of the supply and declare this on the VAT return as both a purchase and deemed supply, with input tax recoverable subject to the normal recovery rules. For most customers of services affected by the change, there will be no net effect on their VAT return.

3. What is the impact for me as a small sub-contractor on the VAT flat rate scheme?

The flat rate scheme requires that businesses account for a specified percentage of VAT determined by the trade sector, which is calculated on VAT inclusive sales values. As sub-contractors will no longer receive a VAT payment for supplies made, they would need to fund the flat-rate VAT percentage from income – this will reduce profit in most cases. 

Flat rate users should take advice now on the implications of the 1 October changes. For most, it is likely to be beneficial to leave the scheme and adopt standard VAT accounting.

Find out more

To find out more about how these changes might impact your business, please contact me or a member of our Construction & Property or VAT teams. It is imperative to prepare your business in advance of these changes to retain a healthy cash-flow, which is robust enough to ensure business stability and growth.

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