The VAT domestic reserve charge is a change coming to the construction industry that aims to tackle tax fraud, with the existing loophole estimated to cost the UK Exchequer over £100m each year. It comes into effect from 1 March 2021 after previously being postponed to October 2020 due to Brexit, then the subsequent impact of the coronavirus pandemic.
Affecting some businesses operating within the construction industry, the change will impact projects that begin or end after the start date. Carry on reading to find out more, all explained in simple terms.
What is the VAT domestic reverse charge?
The VAT domestic reverse charge requires VAT-registered businesses that purchase construction services to pay VAT direct to HMRC rather than the supplier. This change prevents construction businesses from charging VAT and not paying it back to HMRC themselves.
It applies to certain construction services in the UK, plus the materials used – however, there are certain restrictions detailed by HMRC. As an extension of the Construction Industry Scheme (CIS), it only applies to transactions that are between VAT-registered contractors and subcontractors under CIS.
In other words, the scheme means a VAT-registered customer will be accountable for paying VAT rather than the supplier. This means sub-contractors require the contractor using their services to handle the tax and pay it directly to HMRC.
Who does it affect?
Individuals or business who are VAT-registered in the UK and operating under the Construction Industry Scheme will be affected. It will apply to subcontractors who provide supplies bound by CIS (and payments reported under CIS) to end-users that are VAT-registered. The charge only applies to standard and reduced-rate VAT, but not zero-rated supplies.
What is the impact?
The VAT domestic reverse charge will greatly impact how some businesses within the construction industry manage their accounts. It means businesses will need to consider their current processes and systems carefully before 1 March 2021 to ensure they stay compliant. It will also affect existing projects that finish after the implementation date.
A six-month adjustment period from 1st March 2021 will allow those affected to transition into the new changes. Any accidental errors, whereby the business has shown dedication towards staying compliant, will be given a light touch by HMRC.
If errors happen, they should be corrected as soon as possible. Penalties will be considered during the six-month period if any errors are deemed deliberate.
The impact on accounting
When a sub-contractor supplies work and materials, their invoice will not include VAT, as this will be paid directly to HMRC by the customer through their VAT returns. The customer is therefore responsible for ensuring their accounting practices are compliant.
This means businesses operating under CIS will need to ensure their existing systems are up to date with functionality that considers the reverse charge. Staff should also be trained to understand the legislation change and how to apply it.
Codapay VAT domestic reverse charge functionality
Codapay will be rolling out updates on an as needed basis to clients requiring support for the VAT reverse charge changes. This will help to ensure that those dealing with CIS subcontractors where the charge applies are correctly accounting for DRC VAT on invoices.
