VAT Domestic Reverse Charge
HMRC recently held a consultation requesting views on the proposed introduction of a reverse charge mechanism to combat VAT fraud in the construction sector. Following its conclusion and analysis of feedback, HMRC has published draft legislation in the form of a Statutory Instrument which will become section 55A of the VAT Act 1994 with effect 1 October 2019.
The type of supply to which the reverse charge will apply are borrowed from the meaning of ‘construction services’ in the Construction Industry Scheme (CIS) legislation, Finance Act 2004.
The measure aims to shift the liability to account for VAT on supplies of construction services to the customer, rather than the supplier in certain circumstances. This action will help to prevent cases of ‘missing trader’ or ‘carousel’ fraud within the industry. This type of fraud occurs when criminal businesses, often working in cohesion, obtain separate VAT numbers in order to pass goods and/or services down a supply chain. Eventually, one of the traders in the chain goes ‘missing’ after receiving output VAT from its customers, but before paying the amounts over to the Government. The construction sector is particularly at risk because a labour-only business can charge VAT despite incurring relatively little on its costs, and amounts charged to customers are often significant.
Placing the liability to account for VAT with the customer means that the supplier does not charge or receive an amount in lieu of VAT, removing the risk of that cash not being appropriated to HMRC.
The reverse charge will affect all customers in the supply chain who receive services, which they themselves use to make an onward supply of ‘construction services’ as defined in the legislation – i.e. to the final contractor in the supply chain. Therefore, for example, a contractor receiving supplies from a sub-contractor who passes them on to their customer as part of a further supply of construction services project, must reverse charge the supplies of the sub-contractor. However, a main contractor receiving supplies which it consumes in its final supply of a completed property will not.
There are exceptions, such as for certain supplies made to contractors operating in the same VAT or corporate group.
All of that does of course lead to change in the way small VAT registered sub-contractors must account for VAT going forward. Whilst a sub-contractor will no longer charge VAT on their supplies, it is assumed that the current domestic reverse charge provisions which apply to other supplies (such as electricity and gas) which requires a supplier to show the amount of VAT to be reverse charged will need to be followed. A sub-contractor will still be making taxable supplies which entitle them to remain VAT registered and recover input VAT on their costs.
There will also be further administrative complications, such as specific wording which must be included on invoices etc. Details of further administrative requirements will likely be provided via an update to VAT Notice 735 in due course.
If you would like to discuss VAT with us in more detail or if you would like to speak with a member of our Construction & Real Estate team, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with your local representative.
This article featured in issue 10 of our construction and real estate newsletter series. Read the full newsletter here: Real Estate Matters Issue 10