05 July 2022
Many operators in the construction industry still do not understand the rules surrounding the new domestic reverse charge (DRC) and how they apply to their business, despite it being introduced over a year ago.
The DRC, introduced on 1 March 2021, was designed as an anti-fraud measure with the aim of reducing VAT fraud in the construction sector. Where the DRC applies, customers must self-account for the VAT due to HMRC instead of the supplier charging VAT to the customer on their invoice. The reverse charge typically applies to supplies of construction services by sub-contractors to main contractors but can also apply in other cases.
While simple in concept, the DRC rules are complex in the detail and construction and real estate advisers are still seeing a general lack of understanding of the rules across the industry. Over a half of the respondents to a recent RSM poll said that they either had not heard of the DRC or had difficulties operating it. HMRC’s detailed guidance is not straightforward for businesses to navigate and, since the rules were introduced, HMRC has not updated it to reflect the practical issues and challenges faced by taxpayers in implementing the DRC.
During an initial ‘light touch’ period of six months, HMRC did not seek to levy penalties on taxpayers that had applied the DRC incorrectly, provided that they did not deliberately exploit the rules. However, we are already starting to see HMRC asking questions about how businesses have applied the DRC as part of its VAT return enquiries. Now the new rules have been in place for more than a year, it would be reasonable to expect that HMRC will begin to issue penalties to taxpayers that are found to have made errors.
HMRC’s approach is that the DRC should be the default position and that VAT should not be charged without a specific reason. However, in reality, suppliers are more cautious of not charging VAT. Where there is doubt over whether the DRC applies, many would prefer to charge VAT rather than leave themselves at risk of an assessment for under-declared VAT. This leads to a risk for customers that try to recover the VAT that may have been incorrectly charged.
A lack of understanding of the complex rules means that some construction businesses may have overlooked their responsibilities under the DRC. Similarly, taxpayers that initially concluded that their activities fell outside of the DRC may find that changing circumstances mean they are now caught by the rules. Businesses should continue to review how the DRC applies to them to ensure that they remain compliant and avoid penalties. We would welcome improved and updated guidance from HMRC to support businesses with this.