The Domestic Reverse Charge – a new method for collecting VAT in the construction industry
A major change to the way VAT is collected in the construction industry is on its way – and it will have a significant impact on cashflows and processes.
From 1 October 2020, contractors will not pay VAT on sales invoices from one supplier to another. Instead, the VAT will have to be paid directly to HMRC.
Known as the Domestic Reverse Charge (DRC) it has been designed to combat missing trader fraud. According to HMRC, the government is losing £100m of revenue through this practice. In effect, it means the trader deliberately fails to pay the VAT that it’s liable to pay for taxable goods made in the UK.
The changeover was originally planned for 1 October 2019 but has now been delayed until 2020. Many contractors and subcontractors are still unaware of how this will affect their business.
The changes explained
Under the new system, VAT will not pass between the main contractor, subcontractor and HMRC. Instead, the main contractors will be responsible for passing on the relevant VAT amount to HMRC.
The new rules only apply to transactions between VAT-registered contractors and subcontractors who are registered with the Construction Industry Scheme (CIS).
Services covered include :
- Groundworks and other preparatory works, such as demolition
- Building alterations and repairs
- Installing systems such as heating, lighting, power or drainage
- Painting and decorating (internal and external)
If companies do not prepare the new rules will have potentially serious consequences on cashflow as well as VAT compliance.
When will the Domestic Reverse Charge not apply?
There are some instances where the DRC will not apply:
- Construction services which are supplied to the end user, such as homeowners
- Where the recipient supplies the services that it receives from the contractor to a connected company
- When the supplier and recipient are a landlord and tenant
What do contractors need to do?
HMRC recommends that businesses take the following steps to prepare:
- Check whether the reverse charge affects sales, purchases or both: review all transactions for products and services that your business sells to and receives from other VAT registered contractors
- Consider what impact the change will have on your cashflow: including any contingency plans that should be put in place to help mitigate the risks.
- Inform staff: make sure staff who are responsible for VAT accounting are familiar with the reverse charge and how it will operate
- Check systems: make sure that accounting systems and software are updated to deal with the reverse charge
When it comes to the latter point, it is likely that significant process and system changes will be required. This will include how VAT is accounted for on invoices, including making it clear where the DRC applies.
