Domestic reverse charge in the Construction Industry from 1 March 2021

Mon 04 Mar 2019

Background

At the Autumn Budget 2017, the Government announced plans to introduce a domestic reverse charge (DRC) in the construction industry with effect from October 2019.  Revenue and Customs Brief 10/2019 has since announced a deferral of the start date to 1 October 2020.  This was then further deferred until 1 March 2021 (see here).

The impact of DRC is that in the construction industry, the customer in the transaction will now become responsible for accounting for VAT.

In terms of the supplies which will be caught by the domestic reverse charge, this will follow the existing rules around what constitutes ‘construction operations’ for the purposes of the Construction Industry Scheme (CIS).

Why is the Government making this change? 

The construction industry is seen as a high risk sector for fraud and the evasion of tax. In recent times there has been an increase in organised crime groups setting up businesses with the intention of fraudulently failing to pay VAT and making incorrect tax deductions through CIS, through ‘phoenix trading’.

Since the 1970s, CIS has been in place to help counter any evasion of direct taxes (income tax and NIC), however there has not been a similar mechanism for indirect taxes (VAT).

By introducing the domestic reverse charge in the sector, the Government is looking to counter any loss of VAT to the Exchequer, and follows existing mechanisms in place in the telecoms and energy sectors. A reverse charge mechanism in the construction industry is also common in other EU member states.

What is the impact of the domestic reverse charge? 

The Government has confirmed the following:

• To prevent the provider of the goods or services from disappearing or failing to pay the VAT due, the purchaser of the goods or services will account for the VAT due to HMRC by declaring the VAT due as output tax on its VAT return. The purchaser will also be able to reclaim the VAT as input tax under normal rules.
• The domestic reverse charge will apply from 1 October 2020, to give time for businesses to incorporate the new rules into their existing processes, including accounting and IT systems.
• Sales to the final business or domestic customer will be outside the scope of the reverse charge.
• To prevent anti-avoidance, there will be no threshold to exclude any business, widening the scope of the changes.

Will there be any changes to the Construction Industry Scheme (CIS)? 

During the consultation process, the Government discussed the potential to change the criteria for subcontractors looking to obtain gross payment status (i.e. receive payment without deduction of tax). However, as this could impact compliant businesses adversely, this change has not been enacted. Instead, HMRC has stated it will increase its review of the compliance test to look for evidence of fraudulent activity.

Despite no legislative changes to CIS  we have seen increased activity from HMRC within the sector, including compliance visits where a number of common errors have been identified by HMRC resulting in underpayments of CIS tax. As HMRC will seek any underpayments of tax under CIS from the contractor, such errors can be expensive. For example:

• Failure to determine that a construction contract is within CIS;
• Incorrectly excluding activities from CIS (i.e. repairs which involve rectification to part of a building);
• Subcontractors overstating material elements or including the cost of their own plant or scaffolding as a deduction;
• VAT registered subcontractors including VAT as part of their material costs; and
• Failure to apply CIS to certain recharges between entities within an organisation.

What do I need to do? 

The impact of these changes are wide ranging, and as you are operating in the construction industry, it is crucial to plan now to ensure your organisation is ready for the changes. When considering if a payment is within CIS, the consequences of getting this wrong will not only result is CIS failures but from October 2019, VAT issues.

Key action points include:

• Training key internal stakeholders with responsibility for aspects of your existing CIS processes – typically Finance, Accounts Payable, Procurement and Payroll.
• System reviews – update VAT accounting and invoicing procedures / policies to ensure the domestic reverse charge is applied correctly.
• Impact on cash flow.
• How to apply the reverse charge if you are within the Flat Rate Scheme.

How we can assist 

Using our experience working within the construction industry, and our specialist advisers within VAT and CIS, we can assist to ensure you are both process and system ready for the changes from 1 October 2020.

A common approach we have taken with clients is to undertake an interactive internal workshop with key stakeholders within your organisation to review the existing CIS processes and procedures.

The purpose of the workshop will be to educate key individuals in the CIS process of the new changes in relation to the domestic reverse charge, as well as identifying where controls can be put in place / strengthened to ensure your subcontractor payment process will be both CIS and VAT compliant.

For further details please do not hesitate to contact your usual Mazars contact.