VAT: A new reverse charge for building and construction services

The Government has published a final version of the draft legislation, in the form of a statutory instrument, which will introduce a VAT domestic reverse charge (DRC) for building and construction services with effect from 1 October 2019. A tax information and impact note has also been published. Read more here. If you supply or buy building services (see Type of Work Affected below) your VAT accounting will be affected by this measure.

The measure is designed to combat missing trader VAT fraud in construction sector labour supply chains which HMRC says presents a significant risk to the Exchequer.

Under the new rules, supplies of standard or reduced-rated building services between VAT-registered businesses in the supply chain will not be invoiced in the normal way. The domestic reverse charge will only affect supplies at the standard or reduced (not zero) rates where payments are required to be reported through the Construction Industry Scheme (CIS). Under the DRC a main contractor would account for the VAT on the services of any sub-contractor and the supplier does not invoice for VAT. The customer (main contractor) accounts for VAT on the net value of the supplier’s invoice and at the same time deducts that VAT – leaving a nil net tax position.

The DRC only applies to other construction businesses which then use them to make a further supply of building services, and not to ‘end users’ End users are those who receive building and construction services for their own use and do not supply those services on along with other building and construction services e.g. private individuals, retailers, and landlords. There are no de minimis limits, but the RC will not apply to associated businesses.

Type of work affected

Despite the rather misleading reference to ’construction’ the DRC will, in fact, apply much more widely to services in the building trade, including but not limited to, construction, alteration, repairs, demolition, installation of heat, light, water and power systems, drainage, painting and decorating, erection of scaffolding, civil engineering works and associated site clearance, excavation, foundation works. The definitions in the draft legislation have been lifted directly from the CIS legislation.

Excluded works

Some works will not be covered and invoicing for these will not change. These include

  • professional services of architects or surveyors, or of consultants in building, engineering, interior or exterior decoration or in the laying-out of landscape
  • drilling for, or extraction of, oil, natural gas or minerals, and tunnelling or boring, or construction of underground works, for this purpose
  • manufacture of building or engineering components or equipment, materials, plant or machinery, or delivery of any of these things to site
  • manufacture of components for systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection, or delivery of any of these things to site
  • signwriting and erecting, installing and repairing signboards and advertisements
  • the installation of seating, blinds and shutters or the installation of security.

Mixed supplies

The DRC is designed so that if there is a reverse charge element in a supply then the whole supply will be subject to the domestic reverse charge. This is to make it simpler for both supplier and customer and to avoid the need to apportion or split out the supply.

In addition, if there has already been a DRC supply on a construction site, if both parties agree, any subsequent supplies on that site between the same parties can be treated as DRC supplies. HMRC say this should reduce doubt and speed up the decision making process for both parties.

If still in doubt, provided the recipient is VAT registered and the payments are subject to CIS, HMRC state that it is recommended that the DRC should apply.

Issues to consider and preparation

The idea of having draft legislation and guidance out now is to allow businesses a long lead in which to make the necessary changes to systems, prior to implementation on 1 October 2019. Both suppliers and customers will need to ensure that VAT accounting systems under the Making Tax Digital proposals can cope. This is a period in which businesses will also be coping with or preparing for Brexit. At present there is little information on what neds to be done in relation to projects that are in progress when the measure comes in, but it is likely that services with a tax point date after 1 October 2019 will be accounted for under the new rules – so projects which span that date will have two different VAT accounting treatments.

Suppliers in the building trades

One of the main concerns is the burden for suppliers will be identifying customers who are liable for the RC – i.e. checking VAT registration numbers and obtaining evidence that a customer is an ‘end user’ or not, so that VAT, if due, is invoiced correctly. Affected businesses will need plans in place to ensure that as suppliers they do not charge VAT incorrectly. Traders accustomed to using VAT on sales in their cash flow projections will also need to adjust.

Suppliers will be required to issue DRC invoices which clearly state that the supply is subject to DRC and to provide a breakdown of the value of work at different VAT rates, to allow the customer to account for VAT correctly.

Recipients of reverse charge services

All VAT registered recipients of sub-contracted services will need to ensure they apply the DRC correctly. Output VAT wrongly applied on an invoice by a supplier can be collected by HMRC, but will not be recoverable by the recipient, and failure to operate the DRC could lead to error penalties.

The HMRC guidance states that “it will be up to the end user to make the supplier aware that they are an end user and that VAT should be charged in the normal way instead of being reverse charged. This should be in a written form that is clearly understood and can be retained for future reference.”

More controversially, the guidance also says, “if the end user does not provide its supplier with confirmation of its end user status it will still be responsible for accounting for the reverse charge”. We are not convinced this is legally correct, but it will be in the interests of all end users to ensure that the DRC position is clear. It will be necessary for recipients to have a means of identifying DRC invoices in their accounting systems so that the right output tax is declared to HMRC. Input tax on the DRC will be subject to the same rules as now- i.e. it will only be deductible if it relates to the recipient’s taxable business activities. Charities and other not for profit organisations should be particularly aware of this.

HMRC announce postponement of MTD for some charities and others

On 16 October 2018 HMRC announced that mandatory compliance with MTD for VAT will be postponed for 6 months for VAT registered businesses which have more complex requirements until 1 October 2019. The MTD VAT pilot will be open for these ‘deferred’ businesses in Spring 2019. The 6-month deferral applies to those who fall into one of the following categories:

  • Trusts
  • ‘Not for profit’ organisations that are not set up as a company,
  • VAT divisions
  • VAT groups
  •  Public sector entities that are required to provide additional information on their VAT return (Government departments, NHS Trusts),
  • Local authorities,
  • Public corporations,
  • Overseas based traders
  • Traders who are required to make payments on account
  • Annual accounting scheme users

If your VAT registered business is trading over the VAT registratoin threshold and you do not fall into one of the deferred categories you must keep records digitally and use software to submit VAT returns from 1 April 2019. Those in the deferred categories should be able to access a pilot scheme in early 2019, but are not eligible for the current MTD pilot process, announced on 16 October 2019.

Charities

The date charities are able to join the MTD VAT pilot and are required to comply with the MTD VAT rules depends on their individual circumstances and whether they fall into one of the deferred categories. For example, a charity that is :

  • a not for profit organisation that is set up as a company is mandated for MTD VAT from 1 April 2019, unless they fall into one of the deferred categories (e.g. VAT group)
  • a trust or a not for profit organisation not set up as a company is mandated for MTD VAT from 1 October 2019.

The Charity Tax Group ( CTG) reports that HMRC is still reviewing whether mandation for CIOs and SCIOs will be deferred or not. Also disappointingly, HMRC have confirmed to CTG that there is no change to the “soft landing” regarding digital links requirements, which covers VAT periods commencing between 1 April 2019 and 31 March 2020. This will mean that charities with deferred status, which do not participate in the pilot process, will have less time to adapt to the new rules.

CTG states that for most charities it should not be too difficult to comply with the first stage of Making Tax Digital (where only an API connection is required to send VAT data to HMRC), for example by using bridging software from spreadheets, but that the requirement to implement digital links could be a lot harder.

The advice we and CTG are giving to all charities is to start preparations for MTD now, read HMRC’s Notice and to talk to your software providers ASAP to find out what products they will be offering.

More information from HMRC on Making Tax Digital

On 13 July 2018 HMRC published further information on Making Tax Digital (MTD) for businesses and agents in the run up to the start of the mandatory MTD VAT service from 1 April 2019.

From April 2019 all VAT registered businesses (including charities) with a taxable turnover above the VAT threshold (£85,000) are required to keep their VAT business records digitally and send their VAT returns using Making Tax Digital (MTD) compatible software. Businesses with a taxable turnover below the VAT threshold will not have to operate MTD, but can still choose to do so voluntarily.  A reminder of key principles behind MTD for VAT can be found in our previous article here.

The information includes:

  • A new HMRC VAT Notice. The VAT Notice 700/22  gives guidance on the digital record keeping and return requirements of MTD for VAT including:
    • Who needs to follow the MTD rules and from when;
    • The digital records businesses must keep, and a series of HMRC directions that relax these requirements in certain circumstances (such as where a mixed rate supply is made, where a third party agent makes or receives supplies on behalf of a business, and where a business uses a special VAT scheme such as a retail scheme or the Flat Rate Scheme);
    • How businesses must use software to keep digital records and file their returns from those digital records, including information on when programs do and do not need to be digitally linked in situations where a combination of software programs is used.
    • A number of illustrated examples to show customers how to ensure their specific set-up will be compliant with the regulations from April 2019
  • A page on GOV.UK providing a list of software developers  HMRC is currently working with that have already demonstrated a prototype of their product ready to start testing with businesses and/or agents. Over 35 of these have said they’ll have software ready during the first phase of the VAT pilot in which HMRC is testing the service with small numbers of invited businesses and agents. The pilot will be opened up to allow more businesses and agents to join later this year.
  • A communications pack to provide stakeholders with information to support businesses and agents to prepare for MTD.

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Making Tax Digital for VAT – under a year away

We are less than a year (or only 4 VAT returns to go) before the ‘Making Tax Digital’ deadline of 1 April 2019.

The first stage of Making Tax Digital (MTD) will apply to all VAT registered businesses who are over the VAT turnover threshold (£85,000 until March 2020) from the first VAT return which starts after 1 April 2019. The regulations passed into law in March 2018. HMRC have published an Explanatory Note, a draft VAT Notice and a draft Addendum document outlining ‘user journeys’, which uses diagrams to explain the digital links required between records. These can be accessed here but are subject to future amendment. A detailed chart which compares the current rules with those expected under MTD for VAT can be found on the CIOT website here and we reccommend reading this.

The regulations provide that VAT registered businesses (including charities) must keep an electronic account of information specified in the amended regulations, and must use an approved form of software to prepare and render VAT returns. Under MTD, businesses must keep certain mandatory records in a digital format within ‘functional compatible software’, able to interface with HMRC’s systems, and thus send and receive information to and from HMRC. Taxpayers using multiple accounting software packages to record or calculate information that drives VAT return data must digitally link them to be MTD compliant.

Most of our clients use software to keep their accounting records. However, we are aware that very few of them actually use that software to calculate and declare VAT returns, due to the complexities of partial exemption and business/non-business adjustments. If you are using spreadsheets for that you need to start thinking about how any adjustments calculated via spreadsheet are going to get back into a digital format for submission to HMRC under MTD. At the very least we recommend contacting your software supplier to check whether they will be providing any support, and looking at the ‘user journey’ Addendum document from HMRC. You may need to upgrade to use ‘cloud’ based accounting software.

The main and important issue is that information transfer between internal interfaces and with HMRC must be ‘digital’ (and via third party software) where the records are part of the Making Tax Digital for Business (MTDfB) journey, but adjustments (such as partial exemption) will still apparently be able to be calculated separately and manually via spreadsheet– i.e. this step is not part of the ‘MTDfB journey’. It is noted that the information to be recorded also includes a requirement to separately identify the value of income into standard rated, reduced rated, zero-rated, exempt or outside the scope outputs. HMRC plans a “soft landing” in the first year to allow organisations to transition to the new rules.

The draft regulations provide for exemptions from the digital requirements based on turnover, inability to use electronic systems for religious or practical reasons, and for businesses subject to insolvency. Exempted businesses may opt for the obligations in the regulations to apply to them if they so wish. The amended regulations also provide rules for how business records should be preserved.

Pilot scheme

Businesses can sign up to take part in a MTD pilot exercise from 1 April 2018. The benefit of taking part in the pilot will be being ahead of the game, getting access to support, being kept up to date on how the system is developing, an opportunity to influence the look and feel of the final version, and feedback on how you are getting on with the submissions. There is more information on the pilot here, but please contact us if you need more help.

 

The VAT registration limit – up or down?

Since the publication of the Office of Tax Simplification’s report earlier this month there has been a lot of speculation as to what the Chancellor might do about the VAT registration threshold in this week’s budget.

The suggestion has been that the threshold could be dropped to around the higher tax rate limit of c£43,000, or even to the national average wage, i.e. £26,000 a year, but at the moment we don’t know for certain if the government will implement this, or when it could happen. The average threshold in Europe is around £20k. The idea of lowering the threshold, especially to the lower of those two options, has been met with a lot of anger in the small business community.

What are the issues?

Well, there is a lot of evidence that the current £85k limit is a barrier to growth. This is because the limit causes a ‘cliff edge’ effect where a small business approaching the limit needs a lot more turnover to compensate for suddenly having to add 20% to all its income. So many businesses decide to ensure they stay just short of the threshold by various means, for example by closing for a month each year. That causes ‘bunching’ of business around the threshold and prevents business expansion that might lead to job creation.  Plus, some businesses split themselves artificially into separate operations simply to avoid the limit (“disaggregation”) – with a lower limit there will be much less incentive to do this.

Who might be affected?

On the other hand, lowering the limit substantially would affect hundreds of thousands of self-employed small business owners such as plumbers, gardeners, decorators and similar, who are not planning any whizzy entrepreneurial growth but who are just making a living outside of traditional employment. These businesses already have limited income and will be affected by having to add 20% to their charges – and will have very few costs to offset as input tax. Their customers will be members of the public with no ability to deduct the VAT.

There will be a number of hurdles: –

  • The UK has had a high threshold for a long time and HMRC has not to date had to deal with thousands of small businesses;
  • HMRC guidance has been criticised in the OTS report – it will need to be helpful to a lot of businesses new to VAT;
  • If the lower threshold also brings businesses into Making Tax Digital that will be a big change on top of the requirement to register;
  • The biggest impact will be on businesses which deal direct with the public;
  • For small charities the effect could be very difficult unless the Government also raises the de minimis limit for exempt  activities;
  • Prices will go up, with a possible effect on sales – some businesses may fold.

The OTS suggested some ways in which these effects could be lessened. There could be for example a lower rate for labour intensive service businesses or a change to the VAT Flat Rates, or a tapering requirement to register (though that might make things more complex, not simpler).

We can only guess what is coming. But the in the context of recent press reports on how far richer people seem to be engaged in various off-shore tax planning schemes to avoid paying VAT, the political backlash might not be “Paradise” for the Chancellor.

 

A new timetable for Making Tax Digital – VAT to the fore

On 13 July 2017, the UK Government announced major changes to the timeline for the implementation of Making Tax Digital (MTD). Under the new timetable:

  • only businesses with a turnover above the VAT threshold (currently £85,000) will have to keep digital records and only for VAT purposes. They will only need to do so from 2019.
  • the smallest businesses will not be required to use the system, although they can choose to do so voluntarily.
  • for taxes other than VAT businesses will not be asked to keep digital records, or to update HMRC quarterly, until at least 2020.

Proposals will be put in place when changes are brought forward as part of the Finance Bill, expected to be published soon after the Parliamentary Summer recess. HMRC have provided updated information here.

Significant changes to VAT reporting

Record keeping and quarterly reporting for MTD purposes will be significantly different from current VAT record keeping and quarterly reporting. Although the majority of VAT registered businesses report their VAT figures online, this is only via manual input of final figures onto HMRC’s VAT Online system. MTD will require businesses to use accounting software that can link directly to HMRC’s systems. Businesses will no longer be able to keep manual records.  As the use of spreadsheets in VAT accounting is commonplace, (typically to correct the output from accounting software and to operate partial exemption and other VAT schemes), these challenges should not be underestimated.

Timing

MTD for VAT is expected to take place at the same time as the UK leaves the EU (April 2019). Uncertainty around the VAT treatment of transactions between the UK and EU will inevitably arise, and businesses will need to both understand the tax-technical changes to the rules, and ensure that their accounting systems deal with such transactions correctly.