This is the second part of my series of articles about the introduction of the VAT reverse charge for construction services in October this year.  The first part in the series was an Introduction to the subject, where I explained the background to the subject and why HMRC has extended it to construction services.

What is the reverse charge?

The reverse charge is an anti-avoidance provision where, instead of the supplier charging and paying VAT to HMRC, the customer must include the VAT on the services on their VAT return and pay the VAT to HMRC. This procedure is used in certain business sectors where HMRC believes that there is a significant amount of VAT fraud. In this case, the provisions apply to construction services provided by sub-contractors to main contractors.

Under normal VAT accounting rules, sub-contractors charge VAT on their invoices and collect VAT payments from their contractor clients.  However there is a significant amount of fraud in this sector, where sub-contractors collect VAT payments from contractors, but don’t pay the VAT to HMRC.

By introducing the reverse charge, sub-contractors will no longer charge and collect VAT on their services. Instead, the contractors will pay the VAT directly to HMRC.

From 1 October, sub-contractors will no longer issue normal VAT to contractors.

This means that there will be 2 main changes:

  • on invoices issued by sub-contractors to contractors; AND
  • both contractors and sub-contractors will have to make some changes to the way in which these transactions are shown on their VAT returns.

I’ve explained below how contractors and sub-contractors will account for VAT on services under the reverse charge from 1 October, 2019.

Reverse charge VAT accounting requirements

Let’s take an example where a contractor is building new commercial property.  A sub-contractor provides services valued @ £5,000 net at the standard VAT rate of 20%.

VAT accounting pre 1 October 2019

Under normal VAT accounting rules, the sub-contractor issues a normal VAT invoice, as shown below.

The sub-contractor.

Issues invoice for net value of goods and services PLUS VAT

Net: £5,000 plus VAT @20% = £1,000.

Gross invoice £6,000.

VAT return entries:

  • £1,000 VAT included as output tax in box 1 on VAT return.
  • £5,000 included as net sales in box 6 on VAT return.

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The contractor.

VAT return entries

  • £1,000 VAT in box 4 on VAT return.
  • £5,000 in box 7 on VAT return.

VAT accounting from 1 October 2019

From 1 October, the sub-contractor must NOT charge VAT on their invoice.

Sub-contractor

Issues net invoice £5,000.

VAT return entries

  • £5,000 included as net sales in box 6 on VAT return.

The contractor.

VAT return entries

  • £1,000 VAT in box 1 on VAT return.
  • £1,000 VAT in box 4 on VAT return.
  • £5,000 in box 7 on VAT return.

Subcontractors and VAT invoices

If you’re a sub-contractors, under the new rules, you MUST NOT add VAT to the amount charged to contractors.  However, you MUST include the following information on your invoices

  • Normal information required on a VAT invoice.
  • Wording to explain that the domestic reverse charge applies and that the customer is required to account for the VAT. For example, you could include the following wording : ‘customer to account to HMRC for the reverse charge output tax on the VAT-exclusive price of items marked reverse charge’
  • Show how much VAT is due under the reverse charge, or the rate of VAT if the VAT amount cannot be shown. But remember that you must NOT include the VAT in the amount charged to the customer. You should only charge the VAT exclusive amount.

Either way, you MUST include the reference ‘reverse charge’ on your invoices.  For example, you could use the wording suggested in the second bullet point above which includes the phrase “reverse charge output tax”.  Alternatively, HMRC give some other examples of wording that meet the legal requirement:

  • reverse charge: VAT Act 1994 Section 55A applies
  • reverse charge: S55A VATA 94 applies
  • reverse charge: Customer to pay the VAT to HMRC

Other VAT accounting issues

This article explains the basic principles of how the reverse charge works and what you need to include on invoices if you’re a sub-contractor.  There are, however, a number of other technical issues that you’ll need to understand, including the “tax point”; i.e. WHEN you have to include invoices on your VAT returns, and dealing with other practical situations such as credit notes, refunds etc.  I’ll explain more about these in more detail in later parts of this series.

In Part 3, I’ll explain more about WHO is required to use the VAT reverse charge for construction services.

Marie

August, 2019

 

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