Reverse VAT Charge Guide 2023

Aimed at tackling fraud in the construction industry, the reverse charge VAT rules mean that most subcontractors and contractors must now change the way in which they charge and account for VAT.

The following guide outlines how the new VAT reverse charge works, with key compliance advice for VAT-registered suppliers and buyers.

 

What is the VAT reverse charge?

 

Under the new domestic VAT reverse charge system, if you are a VAT-registered subcontractor supplying qualifying services to construction industry contractors, you must show, but no longer charge, the correct rate of VAT on your invoices. Instead, the contractor must account for the VAT to HMRC in their own return, as if they’ve made the supply to themselves.

The new system applies to activities that fall within the scope of the Construction Industry Scheme (CIS). It covers both standard and reduced rate VAT supplies to VAT-registered individuals or businesses making onward supplies of the services to ‘end-users’, such as landlords, property developers, property owners or tenants.

 

When does the VAT reverse charge apply?

 

In broad terms, the new VAT reverse charge rules state that when a VAT-registered business supplies construction services to another VAT-registered business, they will be required to issue a VAT invoice saying that the service is subject to the VAT reverse charge, but no VAT will be added to the invoice. Technical guidance as to when the charge applies, together with supplier and buyer flow charts, can be found online at GOV.UK. However, as a general guide, the following criteria under the new reverse charge regime can be used to decide whether to apply the normal VAT rules, or whether to apply the domestic reverse charge instead:

 

Supplying building and construction services

If you supply building and construction services as a UK VAT-registered supplier, you must use the VAT reverse charge if:

• your customer is registered for VAT purposes
• payment for the supply is reported under the CIS
• the services you supply are standard (20%) or reduced rated (5%), and
• your customer has not confirmed that they’re an end-user or intermediary supplier.

This means that if the customer is not VAT-registered, the supply does not fall within the scope of the CIS, the supply is zero-rated, or you have written confirmation from the customer that it’s an end-user or intermediary supplier, then the normal VAT rules will apply to the sale.

 

Buying building and construction services

If you purchase building and construction services as a UK VAT-registered buyer, you must use the VAT reverse charge if:

• payment for the supply is reported under the CIS
• the supply is standard or reduced rated
• you’re not using the end-user or intermediary exclusions.

This means that if the supply does not fall within the scope of the CIS, the supply is zero rated, or you’ve provided written confirmation that you’re an end-user or intermediary supplier, then the normal VAT rules will apply to the purchase.

 

What is an end-user or intermediary supplier?

 

Under the new rules, consumers and final customers are end-users. This includes businesses, or groups of businesses, that are both CIS and VAT-registered but do not make onward supplies of the services supplied to them. Intermediary suppliers are CIS and VAT-registered businesses that are connected or linked to end-users. If intermediary suppliers purchase construction services and re-supply them to a connected or linked end-user, without making material alterations to the supplies in question, they’re still treated as if they’re an end user.

The reverse charge does not apply to construction supplies to either end-users or intermediary suppliers where they have notified the supplier in writing of their end-user or intermediary supplier status. Notification of end-user status can be made on paper and sent by post, electronically in an email or in a contract. However, if a customer has not provided written confirmation of their excluded status, the supplier must proceed on the basis that the reverse charge applies and therefore not charge VAT on their invoice.

 

What services fall within the scope of the reverse charge VAT rules?

 

Under the reverse charge VAT rules, there are various examples of when you can and cannot use the reverse charge for construction services. The new system essentially applies to activities covered by the CIS payment rules. This means that you must use the reverse charge for the following services, including those that form an integral part of these, are preparatory to them, or are for rendering them complete, for example, site clearance or site restoration:

• constructing, altering, repairing, extending, demolishing and/or dismantling buildings or structures
• constructing, altering, repairing, extending and/or demolishing of any works forming part of the land, such as roadworks, power lines, water mains, wells and sewers etc
• installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply and/or fire protection systems within any building or structure
• internal cleaning of any building and structure carried out in the course of either their construction, alteration, repair, extension and/or restoration
• painting or decorating the inside or external surfaces of any building or structure.

However, HMRC also provide a list of services where the reverse charge must not be used if these services are supplied on their own, for example, the professional work of architects, surveyors, or of interior and landscape designers; manufacturing or delivering to site building materials, plant or machinery; installing seating, blinds and shutters; installing security systems; or making, installing and repairing art works. If the VAT reverse charge does not apply to the works in question, you should follow the normal VAT rules.

 

Exemptions from the VAT reverse charge

 

There are various exemptions to the new VAT reverse charge, including:

• where the customer isn’t VAT registered
• where the supply falls outside the scope of the CIS
• supplies that are zero rated, as the charge only applies to standard or reduced rated supplies
• where the customer is an end-user or intermediary supplier ‘and’ written confirmation has been provided by them of their end-user or intermediary supplier status.

Supplies by employment businesses, providing staff or workers, are also not subject to the reverse charge, even if those supplies fall within the scope of the CIS. Employment businesses supplying construction workers are, for the purposes of VAT, treated as supplying staff rather than services, where the activities undertaken are not supplies by the workers themselves.

If the supply consists only of materials, the VAT reverse charge will again not apply. This is because the making or delivering of materials used in construction falls outside the scope of the CIS. That said, unlike the CIS, where applicable, the VAT reverse charge will apply to the entire invoice, including both labour and materials. Further, any service that would otherwise be excluded if provided on its’ own, this too will become subject to the reverse charge when provided together with other services to which the charge automatically applies.

 

What do invoices need to include under the reverse charge VAT rules?

 

Essentially, if you work in the construction industry and fall within the new VAT reverse charge regime, sales invoices must reflect the new rules. For example, prior to the new rules coming into force, if you supplied building work as a subcontractor to a contractor in the sum of £2,000, including £1000 for materials, your invoice would’ve been shown as follows:

• Labour £1,000
• Materials £1,000
• VAT @ 20% £400
• Gross £2,400
• CIS deduction £200 (20% on labour charges)
• Total owed £2,200.

Under the new regime, a subcontractor raising an invoice to the contractor who is not the end-user, VAT will not be charged but it must be shown. Incorporated into the terms of the invoice there will need to be a clear instruction that the contractor must deal with the VAT on their own VAT return by applying the reverse charge. Essentially, this means that the contractor does not pay the VAT to the subcontractor for them to then pay this to HMRC, but rather they will account for the VAT that the subcontractor would’ve charged.

Under the new reverse charge rules, applying the above illustration, no VAT will be charged although the invoice must include a note that the VAT that would’ve been payable must be accounted for in the contractor’s own VAT return at a rate of 20%:

• Labour £1,000
• Materials £1,000
• Total domestic reverse charge @ 20% £0 (*)
• Gross £2,000
• CIS deduction £200 (20% on labour charges)
• Total £1,800.

*Reverse charge: section 55A VAT Act 1994 applies to items marked with “domestic reverse charge”, where customers must account for VAT on these items to HMRC at the rate shown.

 

Compliance advice for suppliers and buyers

 

If you either supply or buy building and construction services, you’ll need to know how the reverse charge VAT rules apply to you and how this will impact your cash flow. The rules have already been in force for several months now, so where you are VAT-registered, and supplying or buying services that fall within the scope of the CIS — and none of the exemptions apply — you should already have a system in place to reflect the new rules.

For new businesses, or where new supply relationships are formed, consideration must be given to the application of the VAT reverse charge regime. This means making sure that staff dealing with your VAT accounting are familiar with the reverse charge and how it will apply in all scenarios. You’ll also need to ensure that your accounting systems and software can deal with the reverse charge, whether this be from a supplier or buyer’s point of view.

In very basic terms, if you supply building and construction services, you’ll need to:

• check if your customer is CIS and VAT-registered
• review all your contracts to decide if the reverse charge will apply to these
• where the reverse charge may potentially apply, inform your customers and ask them to confirm in writing if end-user or intermediary supplier status applies to them
• where applicable, make sure your invoices show that the reverse charge applies, so customers will know to account to HMRC on their own VAT return.

If you buy building and construction services, you’ll need to:

• check if your supplier is VAT-registered
• inform your supplier in writing if you fall within an end-user or intermediary exclusion
• where applicable, make sure the invoice you receive is correct and the reverse charge applies to the services provided
• account for the reverse charge on your own VAT return and reclaim it from HMRC in the usual way.

If you have not yet implemented procedures to account for the new VAT reverse charge, or have not yet reviewed all of your existing contracts, expert advice should be sought as soon as possible to avoid getting the rules wrong and penalties being incurred.