The way in which VAT is charged on construction services in the UK will change in 2019, as a result of new anti-fraud rules. Around half of UK construction businesses are expected to be affected.
Why are new rules needed?
The UK VAT authority (HM Revenue and Customs or ‘HMRC’) believes £100m of revenue is lost each year as a result of ‘missing-trader’ fraud, where construction businesses charge VAT to their customers and then disappear before paying it over to HMRC. In order to combat this type of fraud, new ‘reverse charge’ rules will come into force on 1 October 2019, which will have a widespread impact on the construction sector.
How will the new rules work?
Under the new rules, businesses supplying construction services in the UK must not charge VAT where their customer:
· Is registered for UK VAT; and
· Will use the services to make an onward supply of construction services.
Instead of the supplier charging VAT, the recipient of the services must self-account for VAT on the services received. This is known as ‘reverse charge’ accounting.
What services are included?
The new rules will apply to construction services supplied on or after 1 October 2019, regardless of value, even if construction is not the main business activity.
The definition of ‘construction services’ is wide and mirrors the definitions used for the Construction Industry Scheme (CIS). It also includes goods (such as building materials), but only when supplied as a single package with construction services.
There are some exclusions, such as the installation of seating, blinds, shutters and security systems. Professional services of architects, surveyors and consultants are also excluded. However, where excluded services are supplied as a package with other services which are within the new rules, the whole package will be subject to the reverse charge.
There are further exclusions for construction services which are to be used by the recipient to make an onward supply to a connected party or to make a supply between a landlord and tenant.
Company A is a UK VAT registered business which is constructing a retail premises for a property developer. Company A sub-contracts the electrical installation work to Mr B, who is a UK VAT registered electrician.
Under the new rules, Mr B must not charge VAT on his services to Company A. Instead, Company A must charge itself VAT on the value of the services received and pay this over to HMRC through its VAT returns. The same amount of VAT can be claimed as input VAT by Company A on its VAT return. Consequently, the reverse charge is VAT neutral for Company A (i.e. VAT paid = VAT claimed).
Company A would charge VAT in the normal way on its supply of construction services to the property developer. The reverse charge rules do not apply, as the property developer is the final customer in the construction services supply chain. That is to say, it is not using Company A’s services to make an onward supply of construction services, it is using the services to make an onward sale or lease of the newly constructed retail premises.
Why is it important?
As an anti-fraud measure, HMRC can be expected to enforce the new rules strictly. If a supplier charges VAT in error, HMRC will not allow the recipient to reclaim it. Similarly, if a supplier applies the reverse charge rules in a situation where it should have charged VAT, HMRC will seek to collect the under declared VAT from the supplier. In both scenarios, penalties and interest could apply. Businesses in the construction sector will need to ensure that they have a sound understanding of the new rules and have systems in place to ensure that VAT is accounted for correctly.
Many subcontractors will find they are in a regular VAT refund position in future, as they will have VAT to claim on materials and overheads, but will not charge VAT on sales where the reverse charge rules apply. Regularly submitting VAT repayment returns is likely to increase the frequency of VAT inspections from HMRC.
Some businesses will suffer a cash flow disadvantage, where VAT collected from customers is currently used as working capital before being paid over to HMRC.
Another concern is that, in order to correctly apply the new rules, the supplier needs to know what its customer intends to do with the services and will need to be able to evidence this to HMRC. HMRC are undertaking a detailed technical consultation on this issue.
The reverse charge rules will not apply where the recipient of the construction services is not VAT registered. In these circumstances, VAT must be charged in the normal way. However, the non-VAT registered recipient must add the value of construction services received to the value of its sales, when deciding whether it has exceeded the VAT registration threshold (currently £85,000). This is likely to mean that many small contractors who are not currently VAT registered will need to be registered in future.
How should my business prepare?
HMRC are undertaking a further consultation on the draft legislation until 20 July 2018. Whilst it is possible that there may still be some changes to the new rules, they are likely to be technical ‘tweaks’ rather than significant amendments. Final legislation and HMRC guidance is due to be issued in October 2018, allowing businesses 12 months to prepare.
For further details or assistance, please contact a member of our Indirect Tax Group.