You may be aware that the Domestic VAT Reverse Charge (hereafter ‘DRC’) will be introduced from 1 March 2021 as an anti-fraud measure for VAT.
The scheme affects business selling services in the construction industry so if this applies to you then please read on as it will have a reasonably significant impact on how you account for your VAT. If you have any queries then our resident VAT expert Colin French ([email protected]) and will be happy to help.
Does the Procedure Apply to Me?
Broadly, the DRC will only apply to builders that work for other builders. The following checklist is useful:
If you answer “yes” to the first 4 questions and “no” to the 5th then the reverse charge WILL apply.
- Is the customer registered for CIS? The DRC will not apply if the customer is not registered for CIS.
- Is the customer registered for VAT? It is important that a business identifies a VAT registered business as if it does not charge VAT on an invoice to a customer it assumes is VAT registered and turns out isn’t VAT registered, the subcontractor will be liable for any unpaid VAT. You can check a customer’s VAT number.
- Is the work within the scope of CIS? It is important to make sure that the service provided is a CIS service. For example, I provide accountancy services to construction companies, but accountancy is not a CIS service, so does not fall under DRC. Details of what falls under CIS.
- Is the work subject to 5% or 20% VAT? Zero rated and exempt work does not apply to DRC.
- Is the customer an end user for the work? For DRC purposes consumers and final customers are called end users. They’re businesses that do not make onward supplies of the building and construction services supplied to them. For example, if a builder were to work on an private individual’s house, they would be the end user, so DRC would not apply.
Interaction with Other Schemes
Flat Rate Scheme
If you are on the Flat Rate Scheme and the majority of your sales invoices are going to be caught by DRC, we advise that you come off the Flat Rate Scheme. This is because no VAT is charged on the sale and input VAT on expenditure could be claimed under normal VAT accounting, potentially resulting in a repayment.
A business can leave the flat rate scheme at anytime with proper notification to HMRC. If you think this might apply to you then get in touch.
Cash Accounting Scheme
Most construction firms will be on cash accounting for VAT purposes, this is usually to help with cash flow.
Invoices that are captured by the DRC will be entered on the VAT return on the invoice date rather than the payment date.
If this results in the business output tax reducing significantly or the business now has repayment VAT returns, they may want to leave the cash accounting scheme and claim the input VAT on the date of the invoice rather than the date of payment to speed up recovery of their input VAT. Again, get in touch if you think you are caught and want to change to invoice accounting.
Invoicing Customers
There is no complication to invoicing your customer under the DRC, all that is happening is you are no longer charging VAT on your invoice.
Example:
An electrician’s work is subject to the new rules.
The value of the work is £1,000 + VAT at 20%.
Before the DRS the invoice would be £1,000 + £200 VAT = £1,200
Under DRS the electrician will now invoice £1,000 with no VAT.
Invoice Details (HMRC Example Attached)
The electrician must include two pieces of information on all the invoices that are subject to the reverse charge:
- A note to confirm that his customer must deal with the VAT. Say “This invoice is subject to the domestic vat reverse charge for construction – Customer to pay the VAT to HMRC”.
- Either the amount of VAT that the customer will declare as the reverse charge (£200) or at least the rate of VAT for the work in question. So 20% in our case above.
VAT Return Entry for Subcontractor
The electrician will enter the £1,000 sale in box 6 of the VAT return.
VAT Return Entry for Contractor
The contractor receiving the service from the electrician will have to apply the reverse charge to the service received. They will do this by entering £1,000 in box 7 of their VAT return and applying 20% to this figure; £200 (the VAT that would have been charged by the electrician) as output VAT in box 1 of their VAT return.
Unless there is a reason why the builder cannot claim this back as input VAT (for example, the builder has exempt sales or non-business/private adjustments), they would claim £200 back in box 4 of their VAT return, with the net effect being Nil.
Building Materials
The DRC applies to the whole invoice. If building materials are charged as part of the invoice then they form part of the DRC. As the business will not be charging VAT on its services and will be incurring input VAT on the purchases of building materials, the business may find itself in a VAT repayment position. If this helps the cash flow of the business, the business may want to apply for monthly VAT returns to accelerate the input VAT recovery.
5% Disregard Rule
Under the DRC, if an invoice includes both reverse charge work and non reverse charge work then the reverse charge applies to the whole invoice.
However, if 5% or less of the invoice is reverse charge work then the reverse charge does apply and VAT is charged on the invoice as normal.
Example:
A subcontractor works on a contractor’s client premises and the value comes to £1,000. (DRC work)
On the same invoice they also charge the contractor for work on the contractor premises and the value comes to £9,000 (non DRC work).
As the reverse charge work is 10% of the value of the invoice £1,000/(£1,000 + £9,000) X 100 = 10%
the whole of the invoice will qualify for the DRC and the contractor would have had to enter £2,000 in box 1 and 4 of their VAT return and £10,000 in box 7
If the work on the contractors client would have been say £200 in the example above then the value of reverse charge work would have been only £200/(£200 + £9,000) X 100 = 2.17% and the subcontractor would have charged VAT on the total invoice as it falls outside of DRC, i.e. £9,250 + £1,850 VAT.
Extra
Subcontractors must be careful when invoicing and remember which works qualify for the reverse scheme and which don’t.
New builds are generally zero rated and therefore fall outside of the reverse charge scheme.
New build works were goods are not ordinarily incorporated in new build housing are charged zero rated for labour and standard rated for materials (e.g Carpet fitting) this work would fall outside the scope of the DRC whether invoiced as labour and materials or supply and fit.
Goods supplied on hire without labour are outside the DRC.
Scaffolding supplies – erection, hire and dismantling or scaffold fall under CIS and therefore fall under the reverse charge. Scaffold hire only, where the hirer erects and dismantles it themselves does not fall under CIS and therefore does not fall within the reverse charge.
If you have any queries please get in touch and we will do our best to assist.
Kind regards
Max