What is a Reverse Charge?
As from 1st October 2019, HMRC have introduced a new VAT ‘reverse charge’ for building work, which they hope will combat VAT fraud.
The new scheme will mean that building contractors will not pay VAT to their subcontractors, but will account for it themselves. The aim is to combat VAT fraud by denying the subcontractor the opportunity to collect the VAT and disappear with it rather than paying it over to HMRC.
The new scheme is based upon the existing CIS scheme. However, unlike the CIS scheme the new reverse charge will take into account both labour and materials incurred within a supply of building work.
How does Reverse Charge work?
Previously, the subcontractor would charge VAT to contractors who would then reclaim it on their VAT Return. Under the new rules, the subcontractor will invoice the contractor net of VAT. It will then be the contractors’ responsibility to account for the VAT on their services as Output VAT on their VAT return. They will however be able to recover the same amount as input VAT on the same return. So, the net effect to the contractor under reverse charge will be nil.
Please note that HMRC do appreciate that implementing the changes for most businesses may cause some difficulties and therefore will apply a light touch in dealing with any errors made in the first 6 months of the new legislation.
When does the Reverse Charge not apply?
- The supplies concerned are zero-rated – such as the construction of housing.
- Services are supplied to an ‘end user’ such as a property owner, or directly to a main contractor that sells a newly completed building to a customer – the rules apply only to intermediary suppliers along the middle of the chain.
- The recipient makes onward supplies of those construction services to a connected company; or
- the supplier and recipient are landlord and tenant or vice versa.
- The recipient is not VAT registered.
If a contractor outsources some of the work to a sub contractor with a value of £5000, then the VAT treatment will be as follows:-
The subcontractor will issue an invoice for £5000 but no VAT will be included on the invoice.
The subcontractor will receive payment of £5000
As you have not charged VAT no VAT will need to paid over to HMRC on box 1 of the VAT Return
When issuing the Sales invoice under Reverse Charge, the invoice must state ‘that reserve charge applies and that the customer is required to account for the VAT’. You must also clearly state the actual rate of VAT (either 20% or 5%).
Important to note that even though the sub contractor will not be charging VAT on their invoices, they will still need to be registered for VAT. The subcontractor will still be entitled to recover VAT on any materials and expenses which they incur.
Construction Company’s Responsibilities
Once you have received the invoice for £5000 from the subcontractor, you will make the payment for £5000 to the subcontractor.
Remember it will be the Construction Company’s responsibility to account for the VAT.
You would therefore need to decide what the VAT would have been (if you had been charged). This should be stated on the subcontractor’s invoice. In this case it will be 20%. Therefore the VAT Return for this transaction would be as follows:-
Box 1 £1000
Box 3 £1000
Box 4 £1000
Box 5 £0
Box 6 £5000
Box 7 £5000
As you have only paid over to the contractor the net amount, you will need to enter the VAT element on Box 1 of your VAT Return. You will also enter it in Box 4 as input VAT; subject to the normal rules for VAT recovery.
Most company software packages will be able to deal with this transaction, so you will just need to ensure that your package is set up correctly before the new system comes into effect. If you require we can review your software package to ensure that it is set up correctly for the new changes.
If you have any queries please contact our VAT manager, Gill McLatchie on 01782 613141.