HMRC are introducing changes to the way that businesses account for VAT on construction services commencing on 1 March 2021. These changes were originally due to be implemented in October 2019 and again in October 2020, but were postponed both times. However we expect the changes will proceed this time as HMRC have begun writing to construction companies. Accordingly, if your business operates under the Construction Industry Scheme (CIS) and supplies or receives services subject to VAT, this change is likely to affect you.
The above change refers to the Domestic Reverse Charge (“DRC”) and is an anti-fraud measure designed by HMRC to combat missing trader fraud. The new system means that the business supplying the construction services (Contractor) to the End User is the only business in the supply chain responsible for charging VAT. End Users will be the ultimate customers or clients at the top of a supply chain who are responsible for the land or buildings. End Users will not be making the onward supply of construction services.
In practical terms this means that businesses in the supply chain (Subcontractors) no longer charge VAT on their services provided. Instead Subcontractors will enter a notional VAT amount in their VAT returns.
What services are affected?
HMRC has stipulated that the DRC applies to business to business services supplied by a Subcontractor to a Contractor which are subject to VAT and provided under CIS. However, HMRC have also said that the DRC does not apply to labour agencies even though these businesses operate within the scope of CIS. The DRC does not apply to End Users therefore Contractors will continue to charge VAT to End Users as before.
Published guidance in relation to the DRC has been released by HMRC and can be found at the link below:
https://www.gov.uk/government/publications/vat-reverse-charge-for-building-and-construction-services/vat-reverse-charge-for-building-and-construction-services
Are the purchase of goods or materials affected by these changes?
The answer is no as the DRC only applies to construction services. The VAT treatment of the purchase of goods or materials are unaffected by the changes. However, where a Subcontractor also supplies materials as part of their contract, the whole supply (i.e. labour and materials) will be subject to the DRC.
Will the changes affect cashflow?
The introduction of the DRC is likely to impact cashflow for the first number of months after 1 March 2021. If a business historically uses VAT it collects from customers as short-term working capital prior to paying this VAT to HMRC, this source of short-term funding will no longer exist and businesses should plan for this shortfall if applicable. However, the potential cash shortfall will be reversed when the next VAT return is submitted to HMRC as the Subcontractor should either receive a VAT refund or at worst have no VAT liability to pay. Therefore, from a cashflow perspective the DRC is cash neutral in the medium term.
Subcontractors who anticipate they may experience a significant negative cashflow impact in the coming months should consider applying to HMRC to file VAT returns monthly as opposed to quarterly.
Will the changes affect profitability?
No, the changes will not affect the VAT exclusive amount any business pays or charges for services therefore the business profits will not be affected.
Please be aware that the onus is on the Subcontractor to ensure that the VAT treatment adopted in respect of the above is correct, there are several areas each business will need to consider in preparation including the following:
– Review and identify potential cashflow issues that could arise because of the forthcoming changes and plan for this shortfall accordingly;
– Communicate the new system to all relevant staff and ensure people are adequately trained;
– Ensure accounting software is fully up to date and setup correctly;
– Ensure invoices are compliant with the new legislation;
– Contact customers for confirmation of their End User status in accordance with HMRC guidance;
– Contact Subcontractors to inform them of the changes if they do not appear to be aware of same.