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Blog from the Dog - new VAT rules for the construction industry

Another “WTF!” overheard in the office of Rowdens relating to construction clients

While I was sitting under the desks, dreaming of chasing rabbits, I overheard another WTF comment, “where’s the fat”…I must admit, I’m a little shamefaced about words involving fat due to a recent experience.

I took advantage of a momentary lapse in concentration by Penny. She left the lid off the container containing fat balls for the birds in the garden and I thought it rude not to help myself to more than a few. Later that day, I was “sick as a parrot” and have promised myself to avoid all fat balls in the future.

As you can imagine when I heard “where’s the fat” I thought I was in trouble!

Where’s the VAT?

False alarm. It turns out they were discussing what our construction clients will say when they receive the first supplier invoice following the introduction of the new VAT rules for the construction industry.

So, what are the new rules? And why no VAT!?

At the moment we are still awaiting detailed guidance from HMRC on the practicalities of the new rules; so, this is an advance “heads up” to help you prepare for the new rules.

Coming into effect from 1 October 2019, the new legislation has the snappy title of “Construction Services Domestic Reverse Charge” (“CSDRC”). It is designed to counter what HMRC considers to be abuse by a small number of businesses (known as Missing Trader Fraud). 

Missing Trader Fraud is where a trader charges and collects VAT from their customers with no intention of paying this VAT across to HMRC. This legislation has previously been used to counter abuse with “sale” of mobile phones and computer chips (also referred to as “Carousel Fraud”).

Construction Services Domestic Reverse Charge - overview

Broadly (and this is where life starts to get interesting):

  • With effect from 1 October, a business supplying certain construction industry services to a VAT registered customer will no longer include VAT on their sales invoice. Instead, their customer will have to account for VAT under the Reverse Charge rules.
  • The customer will have to ‘pretend’ that they made the supply to themselves and account to HMRC for the VAT that should have been charged on their supplier’s invoice. They will of course - since they are VAT registered - be able to reclaim the same amount of VAT from HMRC (so effectively no VAT is paid by the customer).
  • These rules will not apply to zero-rated supplies (so it is only standard or reduced rate supplies that get caught).
  • The rules do not apply where the customer is the “end user” e.g. Marks and Spencer. In practice, the rules will only apply where the customer is a contractor undertaking work for their customer.

So what Construction Industry Services are caught by CSDRC?

The services caught will be familiar to businesses already using the “Construction Industry Scheme” since the services caught by the CIS rules will also be caught by the CSDRC rules.  

I’ve heard my people in the office say that this is going to be the cause of much uncertainty. At Rowdens, we know from the questions raised by our clients regarding the services caught under CIS, the answer is not always straightforward or obvious.  

Some examples
(Similar to the Jaffa cake conundrum - is it a cake or biscuit? but either way they still taste great!)

  • Tree felling is generally not caught by the CIS rules. However, if the trees are cut down to clear a site in preparation for building an extension, tree felling falls within the Scheme.
  • Internal cleaning is regarded as a construction operation if it’s undertaken whilst the construction project is ongoing.
  • External cleaning or routine cleaning of existing commercial premises (not undergoing any types of construction operation) is not regarded as a construction operation; unless it’s preparatory to painting and decorating.
  • Carpet fitting (but no other floor covering) is excluded from the Scheme. However, if the carpet fitting is part of a mixed contract (see next point below) then all the contract comes within the Scheme.
  • If a contract includes some construction work that is within the Scheme and some that isn’t, all payments made under that contract will come within the Scheme - even if shown on separate invoices. 

The new rules will apply not only to construction work but also to the alteration or repairs to buildings, some types of plumbing and electrical work, site clearance and any goods or materials supplied in conjunction with construction services.

Extra resources

OK, all sounds very interesting, possible scary even, but what are the practical implications?

Cashflow
HMRC acknowledges that there will be an adverse cashflow impact on businesses.  Some businesses use (legitimately) the VAT they collect from customers as working capital before they pay it over to HMRC. If you have gained a cashflow advantage under the old rules, you need to consider what impact the new rules will have on your business.

VAT rates
Bear in mind that construction services can be charged at various rates (0%, 5% and 20%). This means that the onus will be on the contractor to make sure they use the correct VAT rates in reporting the reverse charge VAT on their VAT returns.

Check for VAT registration
Suppliers will need to be sure, before agreeing not to charge VAT, that their customer is both VAT registered and is acting as a contractor, rather than as an end user.  In practical terms, if the supplier incorrectly fails to charge VAT then the supplier will have a problem, having filed incorrect VAT returns. 

The worst case position is that HMRC will require the supplier to issue a VAT invoice to their customer (and therefore HMRC will require a payment from the supplier) and will have to then negotiate payment of the VAT with the customer. What if the customer has ceased trading or refuses to pay the late invoice? This will cause cashflow issues for the supplier.

VAT incorrectly charged cannot be reclaimed
Customers will need to make sure that their supplier does not incorrectly charge VAT on construction supplies that fall within the new scheme. If VAT is incorrectly charged, the customer will not be able to reclaim the VAT that has been incorrectly charged. 

If it comes to light (following a VAT inspection) that VAT has been reclaimed incorrectly, HMRC will ask the customer to repay the VAT reclaimed. In these circumstances, the customer will have to reclaim the VAT incorrectly charged from their supplier. Again, this could lead to cashflow issues particularly if the supplier has ceased trading or refuses to repay the incorrectly charged VAT on a timely basis.

Practical steps to be taken by suppliers

Systems must be in place to identify (and record and retain):

  • Whether or not the customer is VAT registered
  • Whether the customer is the end user or a contractor. It remains to be seen whether HMRC will require contractors to confirm in writing, at the time they place the order with their supplier, whether they are a contractor or an end user.
  • Whether the supply of construction services is caught by the new rules 

Suppliers will also need to be ready to:

  • Answer questions from the customer as to why VAT has not been charged, or indeed why VAT has been charged.
  • Cope with delays in payment whilst the customer decides if the invoice sent is correct in respect of any VAT charged.

Practical steps for customers

  • Be prepared to provide suppliers with VAT number and confirmation of status i.e. contractor or end user.
  • Have systems in place to identify when VAT has been incorrectly charged so the supplier can be asked for a revised invoice.
  • Do not pay a supplier if the invoice incorrectly charges VAT. The customer will be at risk in any VAT inspection if the inspector identifies invoices where VAT has been incorrectly reclaimed.
  • Prepare a “hand-out” to give to suppliers regarding the new rules. This will result in fewer issues.

And finally… will your accounting systems be able to cope with the new rules? Xero will!

Having got to grips with the concept of reverse charging and whether VAT should be charged or not, you need to make sure your accounting software can deal with reverse charges.

My nice friends at Xero tell me that their software will cope with the new rules. I am sure other accounting packages will be in a similar situation but, in the unlikely event that you are not a Xero user, you should check.

As we get closer to 1 October 2019, the team here at Rowdens will be discussing the practicalities of the new rules with clients (and potential clients).  I believe they will be setting up sales invoice templates for customers so that any “wording” required by HMRC, on invoices issued under the reverse charge regime, are automatically included.

Thanks for reading all of this blog which is a fair bit to digest (fat balls besides). Being a Labrador and although very knowledgeable in all subjects canine-related, you might have more questions and need advice, so please contact the nice team here at Rowdens.

Lyra