Reverse Charge VAT for Construction

HMRC will introduce a new reverse charge tax system for VAT, with a big impact on the construction industry, especially on smaller subcontractors.

The new rules will mean that the customer will now be liable to account for VAT on purchases, rather than the supplier.

In this article, we look at what the changes mean for businesses at every stage in the construction supply chain, and offer an example application. We’ll explore the potential impact on working capital and subcontractor relationships, and how a supply chain finance facility can help improve cash flow under the new rules.

Why has the VAT reverse charge been introduced?

The new system has been introduced in a bid to tackle missing trader fraud in the construction industry.

This occurs when criminals set up construction companies, operating as regular firms – but siphon off VAT as it moves up the supply chain.

These VAT fraudsters typically operate for a period of between six and nine months before closing the business and vanishing without paying HMRC any of the tax due.

Scams like these have been around for a while, having started off in the electronic goods trade, and emerging in the construction sector only in the last few years. The government and HMRC are cracking down on these sectors one by one – and in 2019, all eyes are on construction.

How will the new construction reverse charge VAT work?

The new reverse charge taxation system will be introduced from October 2019 and will mean that VAT cash will no longer flow between businesses.

For every transaction made, VAT will be registered and clearly stated on the invoice as a reverse charge. Rather than the supplier charging and accounting for the VAT, it is the end user of those supplies who accounts for the VAT.

If a specified supply is made to an end user, then VAT continues to be charged in the usual way. Usually, there would be no impact on the VAT registered customer from a cash flow perspective, but there will be a cash impact for the suppliers and smaller subcontractors on whom many large construction firms rely heavily.

Reverse charge for VAT – An example application

Mid Build Limited supplies construction services to End Build PLC. As part of this it employs a VAT-registered sub-contractor, Sub Build Partnership. For the month ended 31 December 2018, Sub Build invoices Mid Build Limited £10,000 for services during that month.

Under current rules, Sub Build would invoice Mid Build £10,000 net plus £2,000 VAT (Gross £12,000). Mid Build would pay Sub Build £12,000. It would then report the £2,000 input VAT on its next VAT return to HMRC (and would be able to reclaim against any output VAT). Sub Build would report £2,000 output VAT on its next return and pay this to HMRC.

Under the new legislation, this will change. Mid Build Limited is not an end user, as it then goes on to make specified supplies to End Build PLC (the end user).

When Sub Build invoices Mid Build for the £10,000, it does not charge VAT as this falls under the reverse charge. Therefore, Mid Build will only pay £10,000 to Sub Build.

Mid Build will account for both the sales VAT and purchase VAT of £2,000 on its next return (and so it has a net impact of zero on Mid Build, Mid Build is in the same position as before). Mid Build cash flow will in fact be slightly improved as it does not need to pay Sub Build the £2k VAT amount.

Mid Build would then go on to invoice End Build for its services, charging VAT in the usual way (and so no difference here either).

Impact of the VAT reverse charge on cash position

While businesses like Mid Build and End Build PLC will not be impacted from a cash flow perspective, they will need robust systems to account for the reverse charge and properly identify where it applies.

The main impact is on smaller firms such as Sub Build Partnership. Prior to the change, Sub Build would receive a payment of £12,000. While £2,000 of this was payable to HMRC, that may not have been due for 3 months (depending on where in the VAT return cycle the services were invoiced). If on an annual scheme it could be a year. This vital £2,000 could be used as working capital for up to 12 months, until paid to HMRC.

Under the new scheme Sub Build loses that additional £2,000 cash as it cannot charge VAT to Mid Build (as it is not the end user). This impacts on cash flow at the smaller end of the market. A supply chain finance facility provides an opportunity to bridge this gap.

Who will the construction VAT reverse charge affect?

Essentially, any company that makes supplies that would be reported on a Construction Industry Scheme (CIS) return will be affected. Contractors and sub-contractors who supply their services to larger contractors or work through a recruitment agency or umbrella company will be directly affected.

A supply is subject to the new rules wherever it contains any element of reverse charge (so if a sub-contractor makes supplies of labour and materials, the full value of the onward invoice is subject to the reverse charge).

The reverse charge only applies to supplies of specified construction services to other businesses in the construction sector. Below are a few examples:

• Painting or decorating the external or internal surface of any structure or building

• Installation of heating systems, air-conditioning, lighting, power supply, drainage, ventilation, water supply, sanitation and fire protection in any structure or building

• Construction, repair, extension, alteration, demolition and dismantling of structures or buildings (including offshore installations) whether they are permanent or not

 

There are certain supplies and subcontractors that are excluded from the VAT reverse charge. These primarily include professional services such as surveyors and architects, installation, delivery and machinery – if you need more information, we suggest that you visit the HMRC site.

 

What will be the impact on working capital and liquidity of the new VAT reverse charge?

Smaller businesses who are reliant on VAT income as a working capital buffer will suffer financially and will need to prepare for potential cashflow problems once the reverse charge is introduced. Not an easy ask when banks are reducing their exposure to the industry.

This also has a potential knock-on effect on those larger construction companies who are heavily reliant on these smaller subcontractors. If a subcontractor is in cashflow difficulties, they are likely to favour jobs offering better payment terms, and will be looking at all options to improve their liquidity position.

This creates room for opportunity, especially for well-capitalised construction firms that can leverage the strength in their balance sheet to support the cashflow needs of their hungry suppliers, importantly, without adversely affecting their own cash position. A supply chain finance facility, such as that provided by Woodsford TradeBridge, already helps many such firms and, unlike other lenders, is keen to do more business now and once the changes are in place.

Firms would be wise to review their working capital position now, so that they have plans and systems in place before the change comes in this October. To book a free working capital review for your construction business (minimum turnover £10m), get in touch.