The construction sector is breathing a sigh of relief as HMRC Revenue and Customs Brief 10 (2019) announced a 12-month delay to the introduction of the domestic reverse charge for the construction industry. The changes will now come in to effect from 1 October 2020.
Intended impact of the domestic reverse charge
Concerned to close the VAT gap, HMRC is introducing the domestic reverse charge in order to reduce supply chain VAT fraud in the construction sector. Whilst the new rules are being implemented as an anti-fraud measure, they will generally impact the supply of construction services that are subject to the Construction Industry Scheme (CIS) between VAT registered organisations where the customer is not the ‘end user’.
From 1 October 2020, unless they are an end user the customer will be required to self-account for VAT on construction services subject to a positive rate of VAT (ie the standard rate or the reduced rate) under the reverse charge mechanism. The supplier will no longer account for VAT on sales subject to the domestic reverse charge.
Additional 12 months to prepare for the domestic reverse charge
Although many organisations will have made preparations, the 12 month delay offers a welcome opportunity for all businesses to get fully ready for the changes and we urge those affected to make the most of the additional 12 months to prepare early.
Many sub-contractors that are expected to become repayment traders as a result of the change may have already moved to monthly returns to mitigate the cash flow effect. These businesses may now need to fund the additional cashflow of monthly payment whilst they remain net payers unless those sub-contractors request to move back on to quarterly returns.
Whilst the domestic reverse charge rules are simple in concept, the impact for businesses is more wide ranging than just requiring them to undertake a simple administrative exercise. Construction firms should ensure that they understand their obligations and the impact on their business, particularly in relation to cash flow and accounting processes and controls.
Managing the cash flow impact
Industry statistics suggest that there was a general lack of awareness of the domestic reverse charge and that, as a whole, the construction sector was not ready for the original introduction date of 1 October 2019.
In particular, many sub-contractors may not be prepared for the cash flow impact that will arise as a result of no longer having the benefit of receiving the VAT element of payments from their customers up to three months before the corresponding VAT is payable to HMRC. In addition, customers may be slower to pay their suppliers where VAT is incorrectly charged on sub-contractors’ invoices, further compounding the cash flow impact.
The commercial effect of the cash flow impact for sub-contractors is likely to be felt along the supply chain, and includes the potential for requests for accelerated payment terms and a disrupted labour supply. Businesses that regularly use sub-contractors should discuss the domestic reverse charge with their sub-contractor suppliers to help minimise the impact.
Accounting system changes
Another key issue for businesses in the construction industry is ensuring that their accounting software is capable of processing reverse charge supplies (both from a supplier and purchaser perspective) when required. Many software providers have not yet launched their domestic reverse charge updates and where businesses operate bespoke software more work may be required than previously anticipated to deal with them.
A further challenge for taxpayers is to ensure that VAT invoices that are generated by their accounting system contain the additional wording required by HMRC to be compliant for domestic reverse charge purposes.
For more information please get in touch with Ian Carpenter.