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.

Reverse charge VAT and charities with non-business actvities

A recent First Tier Tribunal (FTT) decision may be very important for charities and other entities which have both business and non-business activities, and are receiving services from outside the EU in respect of the non-business activities.  As the amounts involved in this case are significant it will almost certainly be appealed, but charities which are receiving services (not just investment management) from outside the EU in respect of their non-business activities (such as non-business research or grant funded projects) should consider their position further and if necessary make protective claims to HMRC.

Wellcome Trust Limited (WTL) makes payments to non-EU overseas investment managers relating to the management of WTL’s investment portfolio. In a previous ECJ case it had been confirmed that the management of charitable investments by WTL i.e. the buying and selling of shares, was a non-business activity. It follows that WTL is not entitled to deduct any VAT it may incur on  management of those investments. Where such fees are charged by a UK investment manager (the place of supply thus being the UK) WTL could not deduct VAT.

However, where services are received from outside the EU, the question arises as to whether the place of supply is outside the UK (in which case no VAT applies) or is within the UK under the reverse charge rules, such that WTL must account for UK VAT on the value of the services to HMRC. Article 43 of the Principal VAT Directive states that ‘a taxable person who also carries out activities or transactions that are not considered to be taxable supplies of goods or services shall be regarded as a taxable person in respect of all services rendered to him’. Article 44 then treats the supply of services made to a taxable person ‘acting as such  ’as being made where the taxable person receiving the service belongs. Article 45 provides that services supplied to any person acting in a private capacity are made where the supplier belongs.

Since 1st January 2010, WTL had been accounting for output tax in the UK in respect of investment management services it purchased from non-EU suppliers. It claimed repayment of that VAT, amounting to c£13m, and HMRC refused the claim.

HMRC considered the place of supply to be the UK under Art. 44, so that WTL was right to account for VAT under the reverse charge provisions, whilst WTL asserted the place of supply to be outside the UK and thus UK VAT under the reverse charge is not due. WTL’s argument was that the words ‘acting as such’ in Art. 44 took the Trust out of the requirement to account for VAT on investment management services supplied to it from outside the EU. It was agreed that WTL was not acting in a private capacity so Article 45 was not relevant.

HMRC considered that all taxable persons must fall into either Art. 44 or Art. 45. As it was agreed WTL was not within Art 45 they argued that WTL must account for reverse charge VAT under Art 44 and that the words “acting as such” did not have any effect.

The FTT disagreed. There was a ‘gap’ between Art 44 and Art 45 and that the words ‘acting as such’ excluded WTL from a requirement to account for VAT under Art 44 to the extent that the services received are  for the purposes of its non-economic business activity. The FTT found that there is nothing in the provisions which requires someone to fall within either Article 44 or 45.

Please contact us for further information if you are receiving any services from outside the EU in relation to non-business activities.