Reverse Charge VAT - COINS Expert Insight
Jim Etherton, COINS Senior Product Manager, explains more about the impact ‘Reverse Charge VAT’ will have on the construction industry and how COINS software is ready for the change…
HMRC have announced that the introduction of the VAT Reverse Charge for construction services will be delayed for a period of 12 months until 1 October 2020 to allow businesses more time to prepare.
Why is Construction Reverse Charge VAT being introduced?
HMRC have been experiencing substantial levels of fraud from criminals who have taken control of subcontractors within the construction industry. They have been VAT registered, so charging VAT on their invoices to contractors, but have then disappeared without paying this VAT over to HMRC. This is a type of ‘missing trader’ fraud which has cost the UK government many millions of pounds. The ‘Reverse Charge’ system is designed to combat this fraud by making sure that these criminals do not receive VAT from their customers.
How will Construction Reverse Charge VAT work?
From 1 October 2020, subcontractors within the UK construction industry will no longer add VAT to the amount of their invoices when they are working for other contractors within the industry. Instead they will just indicate on the invoice that the VAT needs to be dealt with by their customer under the ‘Reverse Charge’ system. Their customer (the contractor) will enter the VAT amount on their VAT Return as if they had raised the sales invoice, as well as entering it on their VAT Return in the normal way.
This is best illustrated by a simple example:
Up to 30 September 2020 (normal VAT rules)
Subcontractor:
raises invoice for £1,000 plus £200 VAT;
receives £1,200 from Contractor;
enters Sales of £1,000 in box 6 of VAT Return and Output VAT of £200 in box 1 of VAT Return;
pays £200 VAT to HMRC.
Contractor:
pays £1,200 to subcontractor enters Purchases of £1,000 in box 7 of VAT Return and Input VAT of £200 in box 4 of VAT Return;
receives £200 VAT refund from HMRC.
From 1 October 2020 (Construction Reverse Charge)
Subcontractor:
raises invoice for £1,000 with no VAT but stating that Reverse Charge applies;
receives £1,000 from Contractor;
enters Sales of £1,000 in box 6 of VAT Return;
has no VAT to pay over to HMRC.
Contractor:
pays £1,000 to subcontractor enters Output VAT of £200 in box 1 of VAT Return;
enters Purchases of £1,000 in box 7 of VAT Return and Input VAT of £200 in box 4 of VAT Return;
has no net VAT to reclaim from HMRC.
Note: that in the above example, it is assumed that the contractor is able to recover the full amount of the VAT in their VAT Return. This will not always be the case. For example, recovery of input VAT is blocked for certain items included in new homes.
Why have HMRC not simply Zero-Rated Construction Services for VAT
If HMRC had zero-rated construction services then they would have lost a significant amount of VAT. Although, it may appear that the VAT cash flows for Construction Reverse Charge VAT are the same as if zero rating had been applied, this is not always the case. The cash flows are only the same where the contractor can fully recover the VAT. This depends on the type of construction project and the type of cost.
How will this impact the Construction Industry?
There are two main types of impact: administration and cash flow.
Firstly, this is a big administrative change for the UK Construction Industry. The industry is very diverse and comprises a very large number of small subcontractors in addition to medium and large contractors. Some contractors and subcontractors without specialist tax, accounting and IT expertise will find it hard to understand the changes. There is likely to be some confusion and misunderstanding which will result in errors on invoices, payments and VAT Returns. This, in turn, may result in disputes between contractors and subcontractors on whether the reverse charge should apply in certain circumstances.
Secondly, there will be a cash flow impact which will adversely affect subcontractors and could cause some of them financial difficulties.
This is best illustrated by a simple example:
Up to 30 September 2020 (normal VAT rules)
Subcontractor:
receives £1,200 (£1,000 plus £200 VAT) from Contractor in July;
completes VAT Return for July/August/September quarter in October;
pays £200 VAT to HMRC in early November.
From 1 October 2020 (Construction Reverse Charge)
Subcontractor:
receives £1,000 from Contractor in October;
Completes VAT Return for October/November/December quarter in January;
has no VAT to pay over to HMRC.
Under the rules up to 30 September 2020, the subcontractor has the cash flow benefit of receiving VAT cash from customers which may not need to be paid over to HMRC for around three months. From 1 October 2020, the subcontractor loses this benefit. This is a particular problem in the first few months following the change. Note that in our example the subcontractor has to make their last VAT payment to HMRC under the old rules in early November when their incoming cash flow has been reduced during October/November under the new rules.
Will there be penalties for not applying the Construction Reverse Charge?
Yes, HMRC will be able to impose penalties if construction businesses do not apply the construction reverse charge rules or apply them incorrectly. However, according to the published guidance, ‘HMRC understands the difficulties businesses may have in implementing the domestic reverse charge and will apply a light touch in dealing with related errors that occur in the first 6 months after introduction, where businesses are trying to comply with the new legislation’.
Note: under the new rules it is primarily the responsibility of the contractor making the payment to decide whether the reverse charge applies. If a contractor pays VAT to a subcontractor when the reverse charge should have been applied to the transaction then HMRC can hold the contractor liable if the subcontractor does not pay the VAT over to HMRC.
How will COINS Construction Software help clients to handle this change?
COINS software has included functionality to handle reverse charge transactions since July 2017. Recent enhancements have gone beyond the basic transaction processing requirements into three further areas:
- Automating the required Reverse Charge text on invoices and other documents if there is any Reverse Charge VAT on the transaction so that users do not have to remember to add it;
- Utilities to help users change the VAT codes etc. on subcontractors, customers and many other records within COINS at the point of transition in October 2020;
- Adding new validation rules that will help ensure that users select the correct VAT treatment for transactions. Clients can tailor these rules to their own business situation reducing the risk of mistakes and increasing their level of compliance with HMRC rules. This should reduce the risk of fines from HMRC and of disputes with HMRC and with subcontractors and customers.
Together with these software changes, we have made full documentation including training videos available to all clients. Our support desk and financial consultants have also been fully briefed so that they are ready to handle any queries from clients.
We believe that we have gone beyond what any other software company has done in standard package software, particularly with regard to the new validation rules. As well as helping our own clients in this way, we have actively participated in the HMRC stakeholder group ever since the Construction Reverse Charge was first proposed. Also, through BASDA “The Voice of UK Business Software” we have worked together with other software suppliers to help ensure that the industry as a whole is informed about and prepared for the change.
Is there an additional charge to COINS Construction Software users for this?
No, the necessary software changes have already been made available to clients at no additional charge. Full documentation including training videos have also been made freely available to all clients. The only additional charges will be for any consultancy assistance that clients request – this may be required, for instance, if clients have bespoke invoice print formats which require reconfiguring.
Where can I find more information on the Construction Reverse Charge?
The guidance published by HMRC is available on the following link: https://www.gov.uk/guidance/vat-domestic-reverse-charge-for-building-and-construction-services
COINS customers can find more information on the following link (login required): client-area/construction-reverse-charge-vat-update-august-2019/3009/
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