HMRC consult on new way for building traders to account for VAT

Under rules to come in on 1 October 2019 builders, contractors and other trades associated with the building industry will have to get to grips with a new way of accounting for VAT.

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.

Following an initial consultation in March 2017, HMRC has now published draft legislation, a draft explanatory memorandum and a draft tax information and impact note on the so-called “Reverse Charge (RC) for construction services”. HMRC has asked for comments before 20 July 2018. It is intended a final version of the draft order and guidance will then be published before October 2018.

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. Under the RC 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 RC only applies to other construction businesses which then use them to make a further supply of building services, and not to end users eg 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 RC 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.

Questions and preparation

In addition to the technical consultation HMRC has been engaging with trade bodies, and discussions are ongoing.

One of the main concerns is the burden for traders of identifying customers who are liable for the RC – ie checking VAT registration numbers and obtaining evidence that a customer is an ’end user‘ or not, so that VAT, if due, is invoiced correctly. It seems likely that certification will be required, but none of this is covered in the consultation. There are also questions over the scope of the services covered, and how the supply of ’white goods‘ (where VAT deduction is blocked in most cases), will be dealt with under the RC mechanism.

The idea of having draft legislation and guidance by October 2018 is to allow businesses 12 months in which to make the necessary changes to systems, prior to implementation on 1 October 2019. But this is a period in which businesses will also be coping with or preparing for Brexit and Making Tax Digital. Traders used to including VAT in their cashflow projections will also need to adjust.

Affected businesses will need plans in place to ensure that as suppliers they do not charge VAT incorrectly, or as recipients they apply the RC correctly. Output VAT wrongly applied on an invoice can be collected by HMRC, but will not be recoverable by the recipient, and failure to operate the RC could lead to error penalties.

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 threshold – too high?

As was expected in the Spring Statement the Chancellor announced a call for evidence into the effect of the current VAT registration threshold on growth, The Government believes that the current ‘cliff edge‘ VAT registration threshold may act as a disincentive to growth of small businesses and to consequent improvements in productivity. This was noted by the Office of Tax Simplification in its review of VAT published last year, and which recommended that the Government examine the current approach to the VAT threshold.

Business views on the threshold are divided. Some argue that having a high threshold has the benefit of keeping the majority of small businesses out of VAT altogether, avoiding all the administrative requirements that accompany the tax. Others consider that a lower threshold would reduce distortions of competition.

The Government’s call for evidence is split into three sections:

  • the first explores in more detail how the threshold might currently affect business growth
  • the second looks in more detail at the burdens created by the VAT regime at the point of registration, and why businesses might manage their turnover to avoid registering
  • the third considers possible policy solutions, based on international and domestic examples.

We recommend that any small enterprises, including charities, which are currently trading below or near the threshold explore the paper and the questions it asks as this could mark a fundamental change to the way VAT operates in the UK.

VAT simplification – a tax that is showing its age

On 7 November 2017 the Office of Tax Simplification (OTS) laid in Parliament and published its first report on VAT setting out a range of proposals for simplifying the tax. What was meant to be a simple tax has become highly complex and the OTS report says it has not kept pace with changes in society.

The report contains 23 recommendations for simplifying the tax. Its lead recommendation on the future level and design of the VAT threshold has prompted debate. By enabling many small businesses to stay out of the VAT system the high threshold is a form of simplification, but it costs the UK around £2bn per annum, and evidence suggests that many growing businesses are discouraged from expanding beyond this point. The report looks at options for reducing the current ‘cliff edge’ effect resulting in a ‘bunching’ of businesses just before the VAT threshold, and an equally large drop off in the number of businesses with turnovers just above the threshold.

The 8 core recommendations are:

  • the government should examine the current approach to the level and design of the VAT registration threshold, with a view to setting out a future direction of travel for the threshold, including consideration of the potential benefits of a smoothing mechanism
  • HMRC should maintain a programme for further improving the clarity of its guidance and its responsiveness to requests for rulings in areas of uncertainty
  • HMRC should consider ways of reducing the uncertainty and administrative costs for business relating to potential penalties when inaccuracies are voluntarily disclosed
  • HM Treasury and HMRC should undertake a comprehensive review of the reduced rate, zero-rate and exemption schedules, working with the support of the OTS
  • The government should consider increasing the partial exemption de minimis limits in line with inflation, and explore alternative ways of removing the need for businesses incurring insignificant amounts of input tax to carry out partial exemption calculations
  • HMRC should consider further ways to simplify partial exemption calculations and to improve the process of making and agreeing special method applications
  • the government should consider whether capital goods scheme categories other than for land and property are needed, and review the land and property threshold
  • HMRC should review the current requirements for record keeping and the audit trail for options to tax, and the extent to which this might be handled on-line.

 

Summer Newsletter

Welcome to our Summer news update. Since the last one we don’t seem to have much more clarity on what the post-Brexit business landscape will look like, but we have seen the publication of the European Union (Withdrawal) Bill, which is the most significant piece of constitutional legislation for decades.

We’ve also seen some important cases on property development in relation to pub conversions and student accommodation, and VAT has now become the focus of the upcoming changes to the government’s Making Tax Digital programme.

As always if you have any questions on VAT give us a call on 0208 492 1901 or drop Soc or Linda an email.

Pub and shop conversions

We report on the VAT pitfalls that can occur in converting commercial buildings into residential as illustrated by two recent cases. Get in touch if you are not clear on the rules. Read more

When is student accommodation a dwelling for VAT?

A recent case has highlighted some important VAT differences that contractors and sub-contractors need to be aware of when working on student accommodation. Read more

UK VAT Brexit and EU law- an example

The European Union (Withdrawal) Bill in clause 4(1) aims to convert EU law applicable in the UK the day before the UK leaves the EU into domestic law. This will then be “frozen” and any question as to the meaning of EU-derived law will be determined in the UK Supreme Court by reference to the Court of Justice of the EU (CJEU) case law as it exists on the day we leave the EU.

This is not such a change for us VAT practitioners, because the legislative structure of the UK VAT Act and domestic VAT Regulations are, in principle anyway, meant to reflect EU principles. One of these is that UK VAT laws are as far as possible, meant to be construed in accordance with the Principal VAT Directive (PVD) and the case-law of the Court of Justice of the EU. Where UK law deviates from EU law that principle can be an important benefit for UK taxpayers, who can argue against HMRC for the ‘direct effect’ of the EU provisions, as can be seen from the case of The Learning Centre (Romford) Ltd  in which the tribunal has ruled that HMRC were wrong to force the company to charge VAT on welfare services.

The Bill however provides that the principle of ‘direct effect’ is abolished as from exit day.  From exit day, therefore, it will no longer be possible to base a tax claim on the PVD itself, and the case above, if heard after then, might therefore have had a different outcome.

Making Tax Digital

The 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, though they can volunteer to do so for other taxes. There is still a lot of detail to flesh out. Read more

Spring/Summer Newsletter

Welcome to our Spring/Summer news update. It’s been a busy few months since our last update in January. There’s more detail in the links below.

Brexit

The triggering of Article 50 and the UK’s eventual departure from the EU will have a major impact on UK VAT in the future as we discuss here.

Making Tax Digital

HMRC’s proposals to ‘Make Tax Digital’ will eventually affect how all businesses make tax and VAT returns (though there is a proposed exemption for charities) and is likely to require all businesses to adopt digital accounting and /or adapt their software packages. Whilst the legislation was cut from the Finance Bill due to the election we are told this is a deferral only. There is more detail on the proposals here.

Cultural and Educational exemptions

The European Court has recently decided that the UK is entitled to deny exemption to film screenings by non-profit making bodies in the case of BFI. That means there will be no extension of exemption to other areas, but Brockenhurst College was successful in arguing that the catering and theatrical activities its students provided to third parties were exempt because they were closely related  to the education of the students.

Holding companies

Finally HMRC have updated their guidance on deduction of VAT by holding companies  following cases hear on the CJEU. It was expected this would be issued as an HMRC brief but instead HMRC have updated several parts of their Manuals. This will affect recovery of VAT on mergers and acquisitions

As always if you have any questions on VAT give us a call on 0208 492 1901 or drop us an email.

 

VAT deduction by holding companies

HMRC have finally published updated guidance on recovery of VAT by holding companies. The update had been expected to take the form of a Brief which would be published on Gov.uk but instead HMRC have updated the VAT manuals (also on Gov.uk) instead.

Following the CJEU decision in the joint cases Larentia +Minerva, HMRC has been reviewing their policy in respect of holding companies and deduction of VAT incurred on acquisition costs.

The CJEU held that VAT incurred by a holding company on the costs of acquiring shareholdings in subsidiaries to which it also intended to provide taxable management services, must be regarded as part of a holding company’s general overhead expenditure and  thus as deductible (subject to any partial exemption restriction).

Prior to this case HMRC’s previous policy had been that VAT incurred on the acquisition costs of shares by a holding company was only deductible where it was directly attributable to the provision of taxable services.  They also considered that VAT on costs incurred by holding companies was only recoverable if the intention was to recoup the expenditure by providing taxable services to subsidiaries within a ‘reasonable’ period of time.

The guidance covers:

  • when a shareholding is regarded as bring used as part of an economic activity;
  • whether a holding company is the recipient of a supply;
  • whether a holding company is undertaking economic activity for VAT purposes;
  • whether a shareholding is acquired as a direct, continuous and necessary extension of a taxable economic activity of the holding company;
  • whether there is an intention to make taxable supplies;
  • contingent consideration for management services;
  • the effects of a holding company joining a VAT group;
  • stewardship costs; and
  • mixed economic and non-economic activities.

Businesses considering mergers, acquisitions and corporate restructures should read this guidance.

Revised VAT Notice 701/30 – Education

HMRC have issued a revised VAT Notice 701/30: education and vocational training (26 April 2017) which explains the VAT treatment of education, research, training, connected goods and services, and examination services.

The notice has been updated to explain the treatment of funds taken from the new apprenticeship service account to pay external providers for apprenticeship training with effect from 1 May 2017. This notice cancels and replaces the 25 February 2014 version.

Article 50, the Repeal Bill and the future of VAT

At the end of last month the UK formally triggered Article 50 and the Government published a White Paper on the Repeal Bill, which has clarified how the UK will treat existing European Case law after the UK leaves the EU. This will impact on the future of VAT. Details of the repeal bill can be found here

Background

Currently the European Communities Act 1972 (ECA) gives effect to EU treaties in UK law and provides for the supremacy of EU law. It also requires UK courts to follow the rulings of the Court of Justice of the European Union (CJEU). Some EU law applies directly without the need for UK implementing legislation, but other parts of EU law have to be implemented in the UK through via domestic legislation.

The intention is that the Repeal Bill will repeal the ECA. It will also convert EU law into UK law as it stands at the point of the UK’s exit from the EU. This will give some certainty to businesses and allow them to continue operating in the knowledge that rules will not change significantly and suddenly on the UK’s exit from the EU. It will then be down to Parliament or where appropriate, the devolved legislatures, to amend, repeal or change any piece of EU law (once it has been brought into UK law) once the UK is out of the EU.

The Bill creates powers to make secondary legislation to enable corrections to be made to laws that would otherwise no longer operate appropriately once the UK leaves the EU and will also enable changes to domestic law to reflect the content of any withdrawal agreement made under Article 50. It will also give the UK Government once we havelef the EU powers to change the scope and operation of domestic VAT .

Existing EU case law

Following the EU referendum, there had been significant speculation and varying views on how the UK would treat existing CJEU case law, and its impact on the UK tax legislation once  the UK leaves the EU. The repeal bill clarifies that  case law precedent from the CJEU will continue to apply (for a time at least) and that any uncertainties/disagreements over the meaning of UK law after the UK leaves the EC derived from EU cases will be decided by reference to the CJEU case law as it exists on the day the UK leaves. So the European Court of Justice will no longer have any jurisdiction in the UK, but its existing case law, up to the date of withdrawal, will continue to be binding on UK courts as they interpret EU law that has been converted into domestic law.

The bill  is therefore  likely to give CJEU case law similar precedent status to decisions of the UK Supreme Court and both HMRC and appellants  may continue to rely on case law as they have up to this point.  After exit UK legislation (including that relating to UK VAT) passed by Parliament will take precedence over preserved EU-derived law and thus UK VAT and tax law is likely to start to diverge from EU law gradually as UK case law develops. The Office of Tax Simplification  is also currently considering changes to UK VAT that could be made once the UK exits the EU.

Customs issues

Some bills will be necessary to ensure the law continues to function properly from day one, and this includes a Customs bill to establish a framework to implement a UK Customs regime, because this cannot be met by incorporating EU law.

The likelihood is that a Customs border will come into existence early in 2019 with the potential to cause disruption to movement of goods coming in and out of the UK. It is hoped that the Government will publish proposals as soon as possible. The Customs Declaration Services (CDS) programme was intended to replace the existing system for handling import and export freight (CHIEF) from January 2019. Now that the Government has made a decision to leave the EU Customs Union, there is serious concern that this project will be in place on time.

There is still much uncertainty which can only be addressed when the terms of the UK’s departure from the EU are clearer.