If you buy in building work you are likely to be affected by some radical VAT rules for building work that were imposed from 2021 [originally due to be 2019 but postponed] under the new Domestic Reverse Charge (DRC). So how does the UK VAT Domestic Reverse Charge work?
The new DRC rules will affect more than just building contractors and sub-contractors. The new reverse charge will remove VAT obligations from the supplier of any building services and impose them instead on the customer. It follows that the new provisions will potentially affect every VAT registered organisation that supplies or buys in any building work. This is why the impact of the new DRC will be huge and everyone should know about the new rules.
It is vital that anyone using the Flat Rate Scheme (FRS) and affected by the DRC leaves the FRS before the new DRC rules come into effect. The FRS would leave the same percentage of income due as VAT payable to HMRC even if some of the supplies fall under the DRC so lack of attention here could prove to be very costly.
Any Flat Rate users need to leave the scheme
The DRC will work in line with the Construction Industry Scheme (CIS) which makes sense as many of those affected will already be familiar with CIS, however, as the scope of the new DRC seems to be much wider, there could be a steep learning curve for some people.
Despite the misleading name the DRC will apply to all constructions, alteration, repair, extension or demolition work but not if the project qualifies for zero-rating. The scope of the DRC is vast including installation of heat, light, water and power systems, drainage, erection of scaffolding, civil engineering works and associated site clearance, excavation, foundation works even as far as painting and decorating so we are not only looking at significant projects being affected.
This is a time when VAT registered businesses are being overloaded with VAT related procedure and process changes. Other changes include the double whammy of Making Tax Digital and Brexit, so October is an unwelcome additional challenge.
The new VAT rules for building work mean that the supplier, whether main or sub-contractor, will need to check and validate the customer’s VAT registration status. If the customer is registered then each supplier in the chain has to issue invoices on a reverse charge basis. In turn each customer charges themselves VAT and claims it back according to the normal VAT recovery rules such as partial exemption and non-business restrictions.
Importantly, while each of the suppliers in the VAT registered supply chain will not be charging VAT, they will still need to decide on the correct VAT treatment of the supply and will still need to issue VAT invoices.
- If the customer is not VAT registered then the supplier needs to issue a VAT invoice charging VAT at the right rate.
- If the customer is VAT registered the reverse charge sales invoice needs to inform the customer that the reverse charge applies.
So every supplier will need to be able to issue sales invoices on two different bases, some charging VAT and others under the reverse charge mechanism. On top of this we can realistically expect customers to query more invoices and HMRC to query the resulting increased number of VAT repayment claims. As happens now, suppliers will undoubtedly continue to charge VAT when they shouldn’t. This then exposes the customer to either paying VAT and not being able to claim it back as input VAT (because it was not properly chargeable) or having to persuade the supplier to correct the original invoice. All of this seems likely to cause delays and have a negative impact on cash-flow.
Looking from the customer perspective, while the impact of the new provisions has potential to go much further than the building trade, it will only apply where-
- the customer is either VAT registered (or required to be)
- the work is being received in connection with a business, and
- the supply is being onwardly charged – hence not affecting end users.
While this means that developers, landlords and occupiers will be insulated from the change it also points towards uncertainty for the suppliers. Do they charge VAT or apply the DRC? The answer seems to lie in customers having to inform suppliers whether or not they are an end user and therefore whether VAT should be charged in the normal way instead of being reverse charged. Details of what form this will take are not yet known except that it should be in a written form that is clearly understood and can be retained for future reference. HMRC have said that if the end user does not provide confirmation of its status it will still be responsible for accounting for the reverse charge so attention to detail will be important.
How does the UK VAT Domestic Reverse Charge work? What should I do if I buy in building work?
- Any Flat Rate users should leave the scheme
- Explore how invoicing systems can deal with two different VAT charging bases
- Make sure staff as well as main suppliers and customers are aware of the changes
- Set up an internal process for gathering and validating the customer’s VAT status
- Draft contracts to take account of DRC
- Include DRC in any funding plan taking account of potentially delayed VAT refunds
- Devise an action plan to protect against customer delays while they adjust to the new process
If in any doubt, please check it out. Remember sooner is always better. NB updated following introduction of the DRC rules.