A big change is coming to VAT

A big change is coming for construction firms. From 1 October 2019, construction industry firms will need to change how they account for VAT.

But how many contractors understand the implications of the new rules from HMRC, and how many firms have plans to manage the change?

Since the change was announced in November 2018, only a few articles have appeared in the trade press, which could mean that property developers and constructors with small administrative teams may be unaware of the looming changes – or be unprepared to account for VAT in the new way.

The new VAT rules for construction

HMRC is introducing the domestic reverse charge (DRC) on VAT for construction services. The primary effect of this update is to change the party responsible for charging VAT.

Currently, sub-contractors are responsible for charging and accounting for VAT on supplies to main contractors. But from 1 October 2019 the responsibility shifts to main contractors, who will have to account for VAT. This means that the recipient of services, rather than the supplier, will take responsibility for charging VAT to themselves. This will involve adding VAT to all applicable invoices and including the amount on your VAT returns – even though it is not shown on invoices.

Construction industry VAT: the new rule in action

As an example, let’s take a building firm, Firm A, that has been sub-contracted to provide groundwork services to the main contractor, Firm B.

Firm A must not include VAT when they raise invoices for their services. Instead, Firm B must charge themselves VAT and pay this to HMRC through their VAT returns. However, the same amount of VAT can be claimed as an input, so the VAT reverse charge is typically neutralised. That is, the amount of VAT claimed is equal to the amount of VAT paid.

Why is HMRC changing VAT for builders?

HMRC is introducing this change as a response to the issue of missing trader fraud, in which organised criminal gangs use shell companies to steal VAT, often operating alongside genuine construction companies. HMRC estimates that £100m in VAT is lost each year because of missing trader, or ‘carousel’ fraud. By introducing this measure, HMRC hopes to level the playing field and ensure all traders pay their fair share of VAT.

What is covered by the DRC?

The new VAT rule applies to services defined under the Construction Industry Scheme (CIS). This includes construction, demolition, alteration, decorating, drainage, scaffolding, civil engineering, foundations and excavations.

Some supplies of services are excluded, such as shutters, security systems and seating. Professional services such as architects, surveyors and consultants will not be covered by the DRC, and those sub-contractors will need to account for VAT in the usual way. This change does not apply to zero-rated supplies of construction services.

This new approach to accounting for VAT does not contribute to the VAT registration threshold – so smaller companies can avoid VAT registration while still complying with the rule.

Exceptions to the DRC VAT rule

One key exception to the DRC rule is end-users. When sub-contractors are providing construction services to end-users (recipients who use the services for themselves, rather than selling them on as part of construction services), the DRC does not apply. In such cases, sub-contractors will need to account for VAT in the usual manner. It will be crucial for end-users to notify sub-contractors of their status, so the sub-contractor can treat VAT without applying the revers charge rule.

Is your company ready for DRC?

Preparing for the VAT change will involve advising employees about the rule change, notifying suppliers, adjusting accounting systems and software, and checking that applicable purchase invoices do not include VAT. While these steps are not significantly onerous, it is important that construction firms understand their changing obligations and take the necessary actions to ensure they don’t lose out.

While some organisations, particularly those that already apply the reverse charge rule to purchases from the EU, will adapt easily to the new VAT policy, other traders should seek advice from their accountants or tax advisers.

Some businesses may be impacted by the change, particularly those that previously used VAT charged to their clients as working capital before paying it on to HMRC. Because sub-contractors will no longer be charging VAT, they will no longer have the option to use the VAT in this way.

Will your organisation be affected by the new VAT rules? Has your team taken action to prepare for the domestic reverse charge?