VAT Reverse Charge Delayed to March 2021

Phil Caton, a Senior Associate at legal firm Aaron & Partners, and in this feature for UK Construction Online writes about the delay to the reverse charge initiative due to CVOID-19 and how these VAT changes could affect construction businesses once implemented in March 2021.

In June 2020 the Government announced further delays to the implementation of the domestic reverse VAT charge for building and construction services.

The background to the change in law is that whilst under the current rules it is the supplier of goods or services who is required to account for VAT on those supplies, under the new “reverse charge” rules, a customer receiving construction supplies will be responsible for paying VAT direct to HMRC rather than to the supplier.

The purpose of the rule change is to tackle VAT fraud within the construction industry and more specifically, to prevent issues of fraud where a supplier issues a VAT invoice to a customer, but then fails to account for the VAT to HMRC.

The changes will bring the UK construction industry in line with the majority of EU member states who already operate a reverse charge rule for the construction sector and according to the Government’s consultation paper published in December 2017, the change is expected to raise an additional £100m per year for the treasury in taxes collected.

Who does this impact?

The reverse charge will apply to business and customers (but not consumers) registered for VAT in the UK and will affect customers and suppliers who supply or receive specified services that are reported under the Construction Industry Scheme (CIS).

The reverse charge will apply to business providing Construction Services as defined under the legislation and includes a wide range of services such constructing, altering or demolishing of buildings or the installation of services such as heat, water or electricity.

It will also apply to less obvious construction services such as painting or decorating of any building or structure and so in order to assess whether the reverse charge applies, businesses should consider whether their services are specified or excepted supplies under the legislation.

Businesses should also ask themselves the following key questions to determine whether the VAT reverse charge applies:

1. Does the supply fall within the scope of CIS?
2. Is the supply standard rated or reduced rated (as opposed to zero rated)?
3. Is the customer VAT registered?
4. Is the customer registered for CIS?
5. Has the customer provided confirmation that it is an end user?

If the answer to any of these questions is no, the normal VAT rules will apply and the customer should make payment to the supplier in the usual way but if the answer to all 5 questions is yes, the domestic reverse charge will apply.

When does the rule change come into force?

The changes to the VAT rules were considered during the government consultations in 2017 and 2018 and it was recognised during those consultations that it would be desirable for the new rules to have a long lead time in order to allow businesses operating within the construction industry the opportunity to adapt to the changes.

The new rules were originally intended to come into force on 1 October 2019 but this was postponed for 12 months until 1 October 2020 following feedback from the consultation that some businesses would not be ready to implement the changes required, and to avoid the changes occurring during the same time as Brexit.

The implementation of the new rules was then postponed further in June 2020 by another 5 months until 1 March 2021, to allow further time for business to prepare for the rule change outside of the Covid-19 pandemic.

Whilst the rules are currently anticipated to commence on 1 March 2021, it is strongly advised that businesses check the latest guidance from the Government in case there are any further delays to the date for implementation.

Where will the rule change apply?

The rules will be introduced through The Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) Order 2019 and they will apply throughout the United Kingdom.

The reverse charge will not apply if the customer is not registered for VAT in the UK.

How can businesses affected prepare?

HMRC advises that businesses should check whether the reverse charge rule will affect their sales, purchases or both.  The rule change is expected to have a short-term impact on cash flows, particularly as business that use the VAT they collect as part of their working capital will not be able to receive VAT payments from customers. Businesses should be considering such cash flow issues now and plan accordingly in order to mitigate the impact of the changes in March 2021.

Businesses should also be looking at their contracts and considering whether the contractual terms might need to be varied to accommodate a change in the VAT rules and if so, both parties should discuss ways in which they can vary the terms of the contract to cater for the change in the rules.

For example, the parties may wish to introduce a mechanism within the contract whereby the employer issues their payment notice in the usual way and thereafter, the contractor issues an appropriate invoice, indicating whether or not the reverse charge applies to the supply and subject to that invoice and unless the reverse charge applies, the employer shall pay to the contractor the amount of any VAT properly chargeable in respect of the supply.

HMRC also advise that businesses should ensure that their accounting systems and software are updated to deal with the reverse charge and to ensure that staff who are responsible for VAT accounting are familiar with the reverse charge and how it will operate.

HMRC has acknowledged that implementing the rule change may cause some difficulties for businesses in complying with the new rules to begin with, and has said that it will apply a “light touch” in dealing with any errors made in the first 6 months of the new rules applying, provided that businesses can demonstrate that they are trying to comply with the new legislation and have acted in good faith in doing so.

It is therefore recommended that business familiarise themselves with the rules now in order to demonstrate that they are trying to comply with the new legislation and acting in good faith, should they later require relief from HMRC.

Finally, if a business has doubts as to what it should be doing in order to prepare for the VAT reversal change, it should consider seeking early advice from their legal advisor.