Reverse Charge VAT – Top tips
Liz Bridge, Secretary of the Construction Industry Joint Taxation Committee (JTC) spoke at RedSky’s User Conference about Reverse Charge VAT way back in October 2017. Fast-forward to 2021 and the new legislation was finally introduced. Here Liz explains what companies need to know.
The simple fact is that you can’t do Reverse Charge VAT without new software. No matter how small your business is, you’re not going to be able to manage with a biro and a book. There’s no point in putting your head in the sand and ignoring what’s coming. This is no time to be an ostrich!
You need to get yourself ready now, because Reverse Charge VAT comes into effect on 1 March. It’s going to have enormous consequences for companies across the construction industry.
And I do mean the entire construction industry. Unfortunately, HMRC sometimes refers to it as the ‘domestic’ reverse charge for supplies of building and construction services. That’s actually a very confusing term to use, because many people will take ‘domestic’ to mean that the new legislation refers to housebuilding only. And nothing could be further from the truth because in this context, ‘domestic’ means ‘UK’.
Why is Reverse Charge VAT being introduced?
HMRC has known for some time that construction is being used by organised crime groups to steal large amounts of tax owed to the government.
Currently VAT is charged by the person doing the work and it’s paid by the person receiving the work. It’s entered on both VAT returns: the supplier’s return shows the VAT received, which he must pay to HMRC; and the customer’s return shows the VAT paid out, which he can recover from HMRC.
So under the present arrangement, the VAT – the actual money – moves down the chain all the time, with everybody passing it down to the next person: from the customer to the supplier, to the subcontractor and the next subcontractor before it’s paid to HMRC.
It’s like a game of ‘pass the parcel’. The trouble is, by the time the parcel gets to HMRC, there’s sometimes nothing inside it. That’s because at some point in the subcontracting chain, the money is withdrawn as cash and the VAT simply ‘disappears’.
I work in the courts as a member of the First Tier Tax Tribunal. So I have a lot of experience in VAT fraud cases. One of the most memorable involved buying and selling mobile phones, where probably the trade never existed at all and millions and millions of pounds were lost by HMRC as a result.
Once that particular scam had been exposed, the fraudsters looked around for new opportunities to defraud HMRC and honed in on construction industry labour forces as another way to do it.
In the UK we do seem to have been infected by fraudulent players who can manipulate their way into providing big gangs of workers. They charge VAT and deduct CIS tax, and then quite deliberately the people running the company go missing… and get away with all the cash. The tax money never reaches HMRC.
The thing about this type of sophisticated fraud is that there’s really no way of knowing that you’re being duped. That’s the point.
Reverse Charge VAT is HMRC’s weapon against the fraudsters and organised crime groups who are using the construction industry to attack the UK tax system. Nobody really knows how much is being lost because nobody was there to count it, but it’s generally thought to be around £100 million a year…
How does Reverse Charge VAT work?
At the moment, pretty much anyone who supplies construction work in the UK will invoice or apply for the money due to them and must charge VAT. There are exceptions, of course, such as for traders who are below the VAT threshold and for zero-rated supplies, like housing.
Under today’s arrangements, for every £1,000 of construction work completed, a business bills for £1,200 – and should receive £1,200. It uses the money to pay its subcontractors, cover its overheads and achieve a profit. Every three months the business then deducts any VAT incurred during the course of the work from the £200 and passes the remainder to HMRC.
From 1 March 2021, things are going to be very different indeed. The only companies in the construction chain that will actually bill VAT on their supplies will be those that have contracted with an end user or the customer of the building.
Everyone else, including all subcontractors to a main contractor who interfaces with the actual customer, will treat the VAT as if it has been billed on supplies they receive and as if they had charged it to their customer – but no actual money will change hands.
So, using the example above, whereas the business used to bill for £1,200 (including the £200 VAT) and receive £1,200, from March this year it will only receive £1,000. The amount of VAT paid won’t change at all. This is called ‘reverse charging’ and it means that HMRC gets its money from the contractor at the top of the chain, rather than the bottom.
Let the flowchart be your guiding light
In my role on the JTC I’ve been involved in the negotiations with government about Reverse Charge VAT. Twice HMRC pulled it at a late stage because it wasn’t ready – and because so many people didn’t have the software installed.
I believe the scheme that’s being launched on 1 March is workable, but until you’ve seen a machine in action, you never really know where it’s going to fall down…
The thing I’m most proud of in terms of my work with the JTC is the Reverse Charge VAT flowchart. The legislation now supports and fits the flowchart, which is commercially capable of being followed.
Working from the top of the flowchart, you can ask another firm whether they are VAT registered or not. They should be able to demonstrate that and you should be able to check it. You can then apply the same approach to CIS registration, before asking if they are an end user. If they don’t reply, the flowchart indicates exactly what you need to do: you reverse charge the VAT.
If you’re a construction company and you carefully work your way down the flowchart shown below, question by question, you can be confident that you’ve got it right. All you need to do is to enter it through your software correctly and your VAT return will be correct.
Follow the flowchart and you’re safe, because it was agreed with HMRC. Later down the line, if you’re challenged by HMRC and you can demonstrate that you worked your way through the flowchart conscientiously, then you have a very good defence in law.
If ever you’re stuck, always go back to the flowchart and work every question through carefully from the top. Just keep driving back to the flowchart. It’s the blueprint for success.
*The flowchart shown above is designed for businesses that supply building and construction services. It is designed to help them decide whether to apply normal VAT rules or Reverse Charge VAT. Please note: employment businesses should not use this flowchart – they will invoice for supplies with VAT under normal rules.
What impact will changes to Reverse Charge VAT have?
Reverse Charge VAT is undoubtedly going to cause numerous construction companies considerable cashflow difficulties. Many already struggle to pay their quarterly VAT, or their PAYE, or their trading debts because their creditors haven’t paid them. It’s likely that some will go to the wall as a result of the change.
Why? Because based on the previous example, where £1,000 of work is billed as £1,200 (it includes VAT), after 1 March the business will no longer be able to rely on that additional £200. The use of money is very valuable. Currently companies can use that £200 for up to three months as free working capital, to pay for labour and materials.
That practice will come to an end on 1 March. When you think about it, the £200 never really belonged to that business in the first place – it was always HMRC’s money that they were dipping into. In effect, they’ve been using VAT collected as an emergency unarranged overdraft. Harsh but true.
But it’s not just about the cashflow situation. It’s also about the need to implement new software that’s capable of dealing with Reverse Charge VAT. As highlighted at the outset, Reverse Charge VAT is not for human brains – to avoid scrambling them, you need the right software in place.
Is it time to change the frequency of your returns?
Another problematic issue is also going to arise with the big subcontracting trades.
Roofing is a good example. Let’s say there are quality roofers who work for the main contractor on a big project, rather than for the customer direct. They buy their very expensive materials and pay VAT on them, but don’t get VAT coming in from the main contractor.
At the end of the quarter, HMRC will owe them a lot of money (the refund of the VAT on the materials). What these roofers must do is register to become a monthly trader, so they get their repayments monthly rather than quarterly. It’s going to be far easier to submit monthly VAT returns from March onwards, because it’ll all be done automatically by the software.
Generally speaking, HMRC can repay within 10 working days – so the earlier companies put their tax return in, the quicker they’ll get their money back. There has to be a mindset change: from thinking “I’ll get a penalty if I don’t submit my return by the deadline, but I don’t mind leaving it to the last possible moment” to “I want that repayment from HMRC, so I must get my VAT return done asap”.
Take action NOW
The new rules have been a long time coming, with two failed attempts along the way, but there’s no stopping HMRC this time, so don’t pin your hopes on a last-minute reprieve because it ain’t gonna happen.
Construction companies need to take action NOW. It might seem daunting but believe me, the longer you leave this, the more stress you’ll create for yourself in the long term. Not that there is such a thing as a ‘long term’, of course, because this change is being introduced at the start of March.
Here’s my advice on what you need to do right now, to make sure you’re all set for 1 March:
- Do the groundwork. Look at who’s going to pay you in March and April this year. Request their VAT and CIS numbers and ask them if they are an end user – you need to know this information in order to work out if there’s going to be reverse charging involved. You should also keep a record of your suppliers’ response
- Check that your software produces templates for VAT and for Reverse Charge VAT in the new format, so that they are ready to go – the last thing you want to do on 1 March is to issue a Reverse Charge VAT invoice for work done to the value of £1,000 and find that the system has automatically popped an additional £200 in the right-hand column.
Get your new templates sorted now, so that you can state on your invoice: ‘Work done £1,000’. And on the next line, very prominently: ‘Standard-rated work at 20% reverse charged.’ So at the bottom of the invoice, it should say ‘Please pay me £1,000’ (not £1,200, of course). You need to be able to get these invoices out quickly, without having to fiddle around with the layout and content each time
- Make sure you know how your software works – test, test and test again until you fully understand this. You need to be recording in your software that you are issuing a Reverse Charge VAT invoice. It’s vital that you know how to enter the details correctly.
When you send out a reverse charged invoice, you must put it on both sides of your VAT return. That can be quite a complicated thing to do. You need software where all you’re entering is ‘Work done: £1,000’ and then you simply click the ‘Reverse Charge’ button. The software then does all the work for you.
If you rely on a real human brain to do this, you’ll scramble it, because there are adjustments to make in a lot of columns. Let the accounting system run it for you. I have looked at accounts all my working life. Doing Reverse Charge manually would make me cry and want to eat the carpet! It’s not for human beings. Let the accounting software run it all for you.
- Give your subcontractors your details too – if you also pay subcontractors for work, you’ll want your subcontractors to reverse charge you. So you will need to give them your VAT and CIS numbers and inform them whether you are the end user on a project.
This will help prevent your subcontractors from issuing you with an incorrect invoice on 1 March – if they don’t do it right you’ll have to reject it, which will create extra work for your finance team
- Consider whether it will be advantageous to move from quarterly to monthly VAT reporting, to help with your cashflow – look at your cashflow carefully to work out how you’ll get through March and April, when the usual additional money will no longer available but you will still have a workforce to pay. It’s complicated and there is no ‘rule of thumb’, so talk to your accountant about it and think it through
- Issue your new-style invoices promptly in March – don’t put it off. To keep your cashflow going, you need to be able to put the right invoices out at the right time in March and April. If you submit the wrong type of invoice (eg VAT instead of Reverse Charge VAT), your supplier will simply return it to you and ask for the correct one. And that will slow the payment down.
Is there going to be a lead-in period?
It’s my understanding that HMRC is going to apply a ‘light touch’ for at least the first six months. It’s not a moratorium but as far as I’m aware, if there’s a genuine mistake, HMRC won’t be heavy-handed in its response.
In other words, if you have made a mistake but can show that you didn’t do it deliberately and have managed to correct yourself, it’s likely that HRMC will help you correct it and won’t penalise you. However, if you know only too well what you’re doing and the ‘mistake’ you made has left you with more than you should have, then yes, HMRC will follow it up. Wilful errors will be penalised.
For more information, read HMRC’s public guidance notes.
ABOUT LIZ BRIDGE
Since 1990 Liz has been the Secretary of the Construction Industry Joint Tax Committee (JCT), which comprises representatives from 11 major trade federations operating in construction who jointly lobby on tax issues that affect firms in the industry.
As Head of Tax at the Construction Confederation, Liz led the JTC in many negotiations and discussions with HMRC on legislative change.
She has seen two major rewrites of the CIS Scheme, the introduction of the reduced rate bands for various construction work, the introduction of Landfill Levy and Aggregates Tax, and played a leading role in reaching an agreement with the government on the introduction of Reverse Charge VAT.