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The Effect of VAT Domestic Reverse Charge on your Construction Business?

The Effect of VAT Domestic Reverse Charge on your Construction Business?

Introduction 

VAT domestic reverse charge (‘ VAT DRC’) came into force on 1 March 2021 and is effectively an extension of the Construction Industry Scheme (‘CIS’). The rules were brought in with the hope of reducing ‘missing trader fraud’ which is when a company is set up, collects VAT but then goes ‘missing’ before paying the VAT over to HMRC.

The rules shifted the responsibility of accounting for VAT to HMRC away from subcontractors to main contractors. In doing so, it changed the way VAT is accounted for by subcontractors and main contractors. It also had practical implications on cashflow which we will address below.

Under the scheme, subcontractors who are employed by contractors that are VAT registered, no longer need to charge VAT on their invoices. Main contractors will charge VAT as usual to the end users and will pay the VAT collected over to HMRC.

Although the VAT DRC is linked to CIS, it’s important to distinguish that CIS applies to the labour only element of costs, whereas VAT DRC applies to the VAT element of both materials and labour, or the total supply.

Who does this apply to?

The VAT DRC affects VAT registered construction businesses who supply or receive construction and building services that are reported under the Construction Industry Scheme (CIS). It means the main contractor will be responsible for the VAT due to HMRC instead of the subcontractor. If you’re a main contractor that employs subcontractors or a subcontractor who is employed by a main contractor and you’re signed up to CIS, the VAT domestic reverse charge will apply to you.

Main contractor, Subcontractor or end user?

It is important to distinguish the status of each company / individual in the supply chain to determine the respective responsibilities.

The easiest way to explain this is by using a simple example.

Mr Smith appoints ‘We Build Things Ltd’ as he wants an extension built on his house and a fee quote is agreed at £20,000 + VAT. We Build Things Ltd then appoints ‘Extension Specialists Ltd’ to build the extension and agrees a fee of £10,000 + VAT. Extension Specialists Ltd then appoints ‘Bob’ (a Subcontractor) to physically build the extension and a fee is agreed of £5,000 + VAT.

In this instance, the respective roles are as follows:

Mr SmithEnd user

We Build Things LtdMain contractor

Extension Specialists LtdSubcontractor

BobSubcontractor

(all companies and individuals are fictional)

Cashflow implications

We will use the same example mentioned above to demonstrate the cashflow implications.

We will assume that all of the transactions have occurred on 1 January 2022, and that the VAT payment deadline for all three contractors is the 7 April 2022. We will also ignore the effect of CIS.

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As subcontractors, Extension Specialists and Bob will not charge VAT on their invoices, therefore they will not have the temporary cash benefit of the VAT when they receive payments for their respective invoices. VAT DRC therefore impacts subcontractors cash inflow and means that your VAT returns are likely to be repayment returns, as you are still allowed to claim the VAT on your expenses and costs. You may wish to consider filing monthly returns instead of quarterly returns to accelerate when you receive your VAT repayment.

As a main contractor, We Build Things Ltd will have a cash flow benefit of the VAT element on its invoice to the customer. Furthermore, since Extension Specialists Ltd will not be charging We Build Things Ltd any VAT, this means that We Build Things Ltd will have the VAT for the entire chain in its bank account. However, this will all have to be paid over to HMRC at the end of the relevant VAT filing period.

The VAT DRC will therefore lead to higher VAT payments for main contractors, so it is incredibly important that your cashflow is managed well so VAT payments do not put the company into difficulty.

We recommend that your bookkeeping is always kept up to date, so you are able to accurately determine your VAT liability and ensure you have the required cashflow to settle your VAT payments as and when they fall due.

How to create a compliance invoice

If your work falls with the VAT DRC rules. Your sales invoice to the main contractor must include all the usual elements required to comply with VAT rules. When it comes to the VAT element, although you won’t charge VAT on your invoice, you must include a reference that the invoice is subject to VAT Domestic Reverse Charge. This could be a simple statement like “VAT Domestic Reverse Charge Applies”.

If you are unsure as to whether your business falls within the VAT DRC rules, please get in contact with one of the team who will be able to review your individual circumstances and advise accordingly.

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