VAT – domestic reverse charge for construction services

After some delays the new rules on the domestic reverse charge for construction (DRC) finally came into effect on 1 March 2021.  Hopefully most affected business will have experienced it in one form or another but we have seen many queries from clients on the practical aspects of this and this article serves as a useful reminder of the mechanics of the scheme.

What do you need to know?

This change has been introduced to counter fraud in the construction industry and effectively removes the charge to VAT for contractors in the chain of supply.

• It will start on 1 October 2019
• It only applies to standard rated and reduced rated supplies although mixed supplies will not need to be split
• It does not apply to end users
• It applies to “construction operations” which are subject to the Construction Industry Scheme (CIS). These are set out by HMRC as:
  • construction, alteration, repair, extension, demolition or dismantling of buildings or structures (whether permanent or not), including offshore installations
  • construction, alteration, repair, extension or demolition of any works forming, or to form, part of the land, including (in particular) walls, roadworks, power-lines, electronic communications apparatus, aircraft runways, docks and harbours, railways, inland waterways, pipe-lines, reservoirs, water-mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence
  • installation in any building or structure of systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection
  • internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration
  • painting or decorating the internal or external surfaces of any building or structure
• It also applies to services which form an integral part of, or are preparatory to, or are for rendering complete, the services described in the bullet points above including site clearance, earth-moving excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works.
• Invoices will need to state that the reverse charge is due

How does it work?

In simple terms the onus to report the VAT rests with the contractors rather than the sub contractors earlier on in the supply chain.

In a simple supply chain the position is as follows:

From 1 March 2021 this would change to:

In this scenario the Contractor treats the supply from the sub-contractor as if it was supplied by itself and charges itself VAT (at the standard rate – 20%). Assuming VAT is charged on to the End user, this VAT is recoverable in the normal way.

This reverse charge prevents the sub-contractor from charging VAT and not paying to HMRC.

What do you need to do?

This is all well and good in theory but we have seen the following issues when putting it into practice:

• Training may be required for staff/ contractors
• Some computer systems may need changing to deal with the application of the DRC for
  • Processing the VAT
  • Issuing appropriate invoices
• Sub-contractors may not understand the scheme and just charge VAT as usual – what’s the appropriate remedy?
• What do you do with multiple or mixed supplies?
• End-Users should be charged VAT as normal but need to certify this – the end user may not understand the scheme
• The scheme only applies to CIS operations and there is confusion over what is covered by CIS – who decides?
• What happens if there is a dispute – who is correct?

This is a bit of mindset change in the way VAT operates for a large sector and is still a relatively new change and it is not clear what approach HMRC will take to non-compliance or errors in the application of it in the early stages.  They have said that a light touch will be applied but time will tell.  Given that this is an anti-fraud measure we can expect HMRC to review it as part of its assurance program.

There may well be variations to the scheme as it progresses and HMRC experience it in operation and/ or receive representation from affected bodies.

If you need any assistance in administering the changes please do talk to one of our VAT specialists.

Talk to your local VAT specialist if you need assistance or call, or email, our specialist VAT team.