Major and potentially disruptive changes to the VAT regulations governing the supply of construction services are set to be introduced on 1st October this year.
The government is introducing the changes in an attempt to combat what is called “missing trader fraud”, which sources say could be costing the Treasury £100m in lost tax revenues.
The HM Revenue and Customs (HMRC) has acknowledged that the new rules “may cause some difficulties”, but many industry experts fear that the industry is unaware of the deadline and the possible impact on cash flows for many of the companies affected.
The new tax regime, called the “reverse charge scheme”, will mean that a customer receiving services will have to pay any VAT due directly to HMRC instead of paying it through the supplier’s invoice. Under the current system, the supplier would pay the VAT to the HMRC at a later date.
The fraud occurs when some companies do not pass the VAT onto the HMRC.
The reverse charge scheme will not apply to consumers and will only apply to individuals or businesses registered for VAT in the UK.
In its guidance, HMRC says that the reverse charge will affect firms that “supply specified services under the Construction Industry Scheme (CIS)”, the system under which contractors deduct money from subcontractors’ payments and pass it to HMRC as advance payments towards the subcontractor’s tax and national insurance.
In addition, experts stress that if there is no provision of labour, then normal rules apply.
Alasdair Reisner, chief executive of the Civil Engineering Contractors Association, says: “We think this is going to be a huge issue for the industry and have been briefing members on it.
“We fully support the HMRC’s efforts to eliminate fraud from the construction labour supply chain, but implementation of the change is going to be a challenge.”
He added: “Our concerns are linked to the fact that we don’t think much of the industry is fully aware of the change, and the potential impact on cashflow that it will have for suppliers.
“This will come at a time when the industry is already facing very challenging trading conditions, so we are encouraging all suppliers to make themselves aware of the changes and to model how it is likely to affect their business.”
“If needed, CECA will be providing support to members through the period of the change, and has been working with stakeholders on steps to help mitigate any difficulties.”
Richard Dalton, partner with leading accountancy firm BDO, agrees that the construction industry needs to wake up to the fact that the deadline for the change is approaching fast – and manage the possible impact on their businesses.
Dalton, who leads BDO’s Real Estate and Construction VAT team, said: “Construction companies cannot ignore this, it needs to be dealt with.
“HMRC is concerned about organised crime targeting the sector and has identified a risk that businesses in the supply chain which incur little or no input tax – that is to say VAT on purchases – could charge VAT on their sales and fail to account for that VAT to HMRC.
He explained: “The reverse charge was first proposed and consulted on in 2017. Under the current rules, a VAT-registered business that supplies certain construction services is required to charge and account for VAT.
“Under the new rules, a VAT-registered business which supplies certain construction services to another VAT-registered business will be required to issue a VAT invoice stating that the service is subject to the reverse charge.
“The recipient must then account for the VAT on that supply through its VAT return, instead of paying the VAT to the supplier. The recipient may then recover that VAT amount as input tax, subject to the normal rules.”
He added: “Specifically, the reverse charge will apply where the recipient then makes an onward supply of the same construction services.”
Like Reisner, Dalton warns that the new rules could have an impact on cashflow in many companies.
“HMRC notes that some businesses may suffer a loss of cashflow where VAT is no longer charged – they will no longer be able to use the VAT they collect from customers as working capital before they pay it over to HMRC. This is the most significant impact.”
The HMRC has also stressed that contracts with both reverse charge and non-reverse charge elements – such as supply and fix contracts – will be subject to the reverse charge in their entirety, even the part of the contract that would be excluded if it were being supplied on its own.
“For example, a joiner constructing a staircase off-site then installing it on-site is making a reverse charge service, even if the charge for installation is only a minor element of the overall charge.”
The authorities have said they recognise that companies working on a number of different sites with a large number of contracts that span the October deadline will face particular challenges.
It suggests: “To avoid uncertainty and delay to payments whilst each contract is checked HMRC recognises that it will be easier if one VAT accounting treatment is given to all contracts with a particular sub-contractor.
“So, if the contractor looks across all construction contracts with a sub-contractor and can see that reverse charge applies to more than 5% of contracts by volume or value with that sub-contractor, then the reverse charge may be applied to all the contracts.”
The guidance adds: “For contracts starting after 1st October 2019 you should decide whether the reverse charge applies from the start of the contract.”
In its public statements, HMRC has repeatedly stressed that it will apply a “light touch” in dealing with any errors in the first six months as long as companies have tried to comply and are deemed “to have acted in good faith”.
However, it has also said that it will expect errors to be corrected quickly and has warned that penalties will be considered for anyone regarded as “taking advantage of the measure by not accounting for it correctly”.
One contractor told The Construction Index that they hoped the authorities would keep their word and be lenient with companies that made mistakes.
“To be honest, I think large parts of the industry are pretty unprepared and many aspects of the changes are still unclear.
“I also worry that with the market being so fragile, this may force some of the less robust firms out of business, unless they get to grips with it quickly.”
BDO’s Richard Dalton agrees. “The HMRC’s guidance covers most common situations, but detailed advice should be sought for a taxpayer’s individual circumstances.
“We need as much clarity as possible from HMRC so that everyone is playing by the same rules and we all know what those rules are.”
Contracts that the reverse charge applies to - HMRC guidance in its own words
The HMRC published further clarification of the new rules on 7th June 2019, giving more details about which services are within or outside the scope of the new regulations.
To whom does this apply?
Companies will have to apply the reverse charge if they supply any of these services:
• Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services
• Constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, including (in particular) walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours
• Pipelines, reservoirs, water mains, wells, sewers, industrial plant and installations for purposes of land drainage, coast protection or defence
• Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure
• Internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration
• Painting or decorating the inside or the external surfaces of any building or structure
• Services which form an integral part of, or are part of the preparation or completion of the services described above – including site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works.
HMRC says that the following services are not subject to the reverse charge:
• Drilling for, or extracting, oil or natural gas
• Extracting minerals (using underground or surface working) and tunnelling, boring, or construction of underground works, for this purpose
• Manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site
• Manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to site
• The professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants
• Making, installing and repairing artworks such as sculptures, murals and other items that are purely artistic
• Signwriting and erecting, installing and repairing signboards and advertisements
• Installing seating, blinds and shutters
• Installing security systems, including burglar alarms, closed circuit television and public address systems
What to do now
HMRC says that contractors should prepare for the introduction of the reverse charge scheme by:
• Checking whether the reverse charge affects either your sales, your purchases or both
• Contacting your regular clients or suppliers to let them know
• Making sure your accounting systems and software are updated to deal with the reverse charge
• Considering whether the change will have an impact on your cashflow