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Reverse into it: new VAT rules for the construction industry

February 2021

The domestic VAT reverse charge for supplies of building and construction services is due to come into force in the UK on 1 March 2021 and will change the way in which VAT needs to be controlled by some businesses in the construction industry. In this article, we will discuss the application of the new scheme to building and construction services and the measures that will need to be implemented by affected businesses to ensure compliance with the new rules.

When will the VAT reverse charge apply?

The VAT reverse charge will not apply to all businesses in the construction industry. However, a business must use the reverse charge from 1 March 2021 if it is VAT registered in the UK, supplies the relevant Building and Construction Industry (“BCI”) services and:

1. The customer is registered for VAT in the UK;
2. Payment for the supply is reported within the Construction Industry Scheme (CIS);
3. The services supplied are standard or reduced-rated;
4. It is not an employment business supplying either staff or workers, or both; and
5. The customer has not given written confirmation that they are an end user (i.e. a VAT and CIS registered customer who is not intending to make further on-going supplies of the building and construction services supplied to them) or an intermediary supplier (i.e. a VAT and CIS registered customer that are connected or linked to end users).

The BCI services falling within the scope of the CIS include constructing, altering, repairing, extending, demolishing or dismantling buildings or structures or walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours, pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence. Services falling within the scope of the CIS also include installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure or internal cleaning or painting and decorating of any building or structure.

Some specific services will be exempt from the VAT reverse charge.

Design consultants

Professional services (such as the work of architects, engineers and surveyors) will not be subject to the reverse charge when supplied on their own.

The end user exemption

Where a customer has provided written confirmation that they are an end user, the reverse charge will not apply. There are three categories of end user accepted by the rules:

1. Those who do not make onward supplies of construction services at all (for example, owner-occupiers);
2. Those who make onward supplies to a “connected person” – largely, those who fall within the definition of group companies in the Companies Act 2006; and
3. Where the supplier and the receiver both have a “relevant interest” in the property to which the supply relates.

Utilities

The reverse charge does not apply to individuals or companies who manufacture or deliver building or engineering components or equipment, materials, plant or machinery, or components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems. This means that suppliers of construction services to utility businesses are likely to be outside the scope of the reverse charge.

Design and Build

On a design and build project, the design and build contractor will typically enter into sub-contracts with multiple different suppliers and will provide them as a single supply to the client. A design and build contractor may be a connected party or linked to an end user and therefore be treated as an intermediary supplier. In these circumstances, the normal VAT rules will apply.

International work

Importantly, the VAT reverse charge does not apply to work that it is undertaken overseas; it is limited to UK companies providing construction services in the UK to UK VAT registered customers.

How will this impact the construction industry?

New invoicing regimes

Where the reverse charge applies, the recipient of the service will have to account for the VAT to HMRC via its VAT return, instead of paying the VAT to its supplier. The recipient will still be able to recover the VAT it incurs as input tax in the normal way. Also, the supplier subject to the reverse charge must still issue a VAT invoice. The invoice must make clear that the domestic reverse charge applies and clearly state how much VAT is due under the reverse charge (but not include this in the amount charged to the customer).

Pursuant to the VAT Regulations 1995, invoices for services subject to the reverse charge must include the reference ‘reverse charge’. HMRC has provided some examples of wording that meet the requisite standards which include stating ‘Reverse charge: VAT Act 1994 Section 55A applies’ or ‘Reverse charge: S55A VATA 94 applies’.

Strict requirements

HMRC has indicated that it will apply an initial lenient approach in dealing with any errors to VAT returns made in the first 6 months of the new legislation being rolled out (i.e. to 1 September 2021) as long as businesses have tried to comply with the new legislation and have acted in “good faith”. However, HMRC may consider imposing penalties where businesses deliberately take advantage of the measures by not accounting for VAT correctly.

Cash flow

The reverse charge means that businesses to which the reverse charge applies will make net repayment claims to HMRC because VAT on supplies will no longer be received.

For sub-contractors, it means that the VAT once held for certain purposes before being passed to HMRC will no longer be available. It is therefore prudent for sub-contractors to adequately plan for this impact on day-to-day cash flow in the short term. Transitioning from a quarterly to monthly VAT return cycle to accelerate payments due from HMRC may help to alleviate immediate cash flow implications.

Non-construction bodies

Non-construction businesses may become ‘deemed contractors’ if their average annual expenditure on construction operations exceeds £1m over a three-year period. Businesses with a significant construction spend, such as large retailers and public bodies may therefore fall within the scope of the CIS for the purpose of the reverse charge (provided that the end user exclusion does not apply).

What needs to be done?

Suppliers of services (such as sub-contractors) should:

1. Review their contracts to see whether the type of BCI services supplied will be caught by the new regime;
2. Confirm that their customer(s) has or have a valid UK VAT registration number;
3. Use the CIS online service to check whether their customer(s) is or are registered with the CIS;
4. Ask their customer(s) to confirm if they are an end-user or an intermediary supplier.

A customer can provide notification of intermediary or end user status by providing a written notification electronically or by post. An example of the wording to use by customers is:

“We are an end user for the purposes of section 55A VAT Act 1994 reverse charge for building and construction services. Please issue us with a normal VAT invoice, with VAT charged at the appropriate rate. We will not account for the reverse charge”.

Where the end user or intermediary supplier notification is in a contract issued by the supplier, this will be a valid notification as long as the customer has given written agreement to the contract. If a supplier often contracts with end users or intermediary suppliers, they can include a statement in their standard terms and conditions to state that they are acting on the assumption that the customer is an end user or intermediary supplier unless informed otherwise;

5. Ensure that all staff are appropriately trained and compliance with the new rules extends across the business;
6. Confirm that accountancy practices are configured to enable the reverse charge to be recorded;
7. Make sure invoices show the reverse charge applies in accordance with the VAT Regulations 1995 and do not provide for payment of VAT; and
8. Ensure that any errors in recording the VAT reverse charge are corrected as soon as possible.

Contractors (i.e. purchasers of CIS regulated construction services) should ensure that, from 1 March 2021, the invoices received from CIS suppliers comply with the VAT Regulations 1995 and that they properly account for the VAT reverse charge.

Prior to 1 March 2021, the normal VAT rules will apply.

Take away points

The implementation of the reverse charge will have a significant impact on how businesses within the construction industry account for VAT and manage their cash flows. If you are unsure as to whether the new changes will apply to your business or if you need some guidance on how to deal with these changes, you should seek professional support from your legal or tax advisors or from HMRC directly. HMRC has published some useful guidance here.

It is important to note that HMRC is changing the CIS rules from 1 April 2021 which is expected to bring more businesses within the scope of CIS and possibly increase those caught by the VAT reverse charge.

Should you have any queries or are seeking advice on the matters raised in this article, please do not hesitate to contact us.

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