VAT: reverse charge for building and construction services
by Ashley Crawford, Commercial Director - UK
Changes to VAT compliance is firmly on the agenda for 2019. Ashley Crawford reviews the soon-to-be introduced Construction Services Domestic Reverse Charge (CSDRC) and the impact it will have on the construction industry in the near future.
2019 is set to be a year full of VAT compliance challenges. On 1 April 2019, we saw the introduction of new rules dealing with ‘Making Tax Digital’. In just over five months’ time, on 5 October 2019, the Construction Services Domestic Reverse Charge (CSDRC) charge will be introduced. The introduction of the CSDRC is something that construction companies should be preparing for now—however, since the publication of the draft legislation on 7 November 2018 that will bring this change into effect, relatively few companies are getting ahead of the curve.
This new legislation aims to tackle tax-related fraud. Over the past few years, the Government has become increasingly concerned about fraudsters “stealing” VAT revenue from the Exchequer. This has been carried out by the fraudsters setting up shell companies (or taking over trading companies) and charging VAT to customers on invoices in the normal way. The problem arises when the VAT charged to customers does not flow through the system, eventually reaching HMRC.
Instead, fraudsters keep the money, which has and continues to deprive the Exchequer of significant amounts of tax revenue. Whilst it is the Government’s perogative to address this issue by
introducing legislation, the proposed solution will likely have significant consequences for companies across the construction industry.
Under the new regime, a VAT registered company which supplies certain construction services to another VAT registered company will be required to issue a VAT invoice stating that the services provided are subject to a domestic reverse charge. Specified construction services are determined based on those services currently caught by regulation 4 of the Income Tax (Construction Industry Scheme) Regulations 2005.
The company receiving the services will have to account for VAT through its annual return, instead of paying VAT to the supplier. However, VAT on such invoices may be recovered as input tax, subject to the normal rules. The reverse charge will specifically apply to those supplies made which also require payments to be reported through the CIS. It should be noted that the CSDRC only applies to supplies that are normally subject to VAT at the standard or reduced rate. It does not apply to zero-rated supplies or supplies made by a company that is not required to be registered for VAT (i.e. where the supplier is below the VAT registration limit).
Further, the CSDRC applies only to services that are made to a contractor. It does not apply to an “end user” customer. However, there may be situations when this rule may be relaxed where both parties agree. Further guidance is due to be published by HMRC in the coming months which will shed light on this.
Additional care may also be needed initially, where payment is requested before 1 October 2019 but not made until or after that date. If a supplier charged VAT on a VAT invoice before 1 October 2019, the reverse charge will not apply even if payment is made at a later date. However, if the supplier simply issued a request for payment plus VAT, it may well be that VAT should be added to the payment if it is actually made before 1 October 2019, but not if it is not made until the reverse charge has been introduced.
Impact on the Construction Sector
The Government has acknowledged that the impact of the new regime on the construction industry is likely to be significant and estimates that up to 150,000 construction-sector companies will be affected by the changes.
Companies must ensure they adapt their accounting systems to process reverse charges. The costs of doing this may initially be high depending on the company, but there will also be ongoing costs to consider: calculating the reverse charge; keeping records of all reverse charge supplies; checking the reverse charge is correctly applied; reporting reverse charge supplies on VAT returns; and, crucially, obtaining evidence as to whether a customer is an end-user.
Companies may experience substantial cash flow issues, as they will no longer be able to use the VAT they collect from customers as working capital before it is paid to HMRC—representing potentially a 17% reduction in cash flow for the main contractor.
Not being able to rely on VAT money for cash flow will likely impact on small and medium-sized businesses the most, as these types of companies have for years relied on VAT loans to keep themselves afloat. The onus will soon be on major contracts to pay large sums of money to the Exchequer.
Potential accounting errors in the early days following the introduction of the new regime could mean that some construction companies are pushed into unsustainable levels of debt.
Tax expert, Liz Bridge, who is the secretary to the Joint Tax Committee of Construction which represents many industry federations is unsympathetic: “A well-run company never pays its VAT late, and never has to wait until it is paid to get the VAT money over. Effectively, if you use the VAT, you are borrowing from the state – unarranged and without interest. There aren’t many cases in business where that kind of transaction would be allowed.”
To reduce the potential impact of the new VAT regime, companies should review supplies made to and received from other VAT registered contractors to establish whether they will be subject to a reverse charge from 1 October 2019. At the same time, companies should consider which, if any, adaptations need to be made to their accounting systems to prepare for the changes. Cash flow from October should also be closely considered and ways to mitigate the loss of working capital.