In March of this year, the government published a Consultation document entitled 'Fraud on provision of labour in construction sector: consultation on VAT and other policy options'.
To view the consultation document please click here.
To counter supply chain VAT fraud in the construction sector, the government proposes to institute a 'domestic reverse charge' mechanism (DRC) to collect VAT which might otherwise be subject to fraud.
In this article, we will look at the background to the consultation document, the government's proposal to introduce a DRC to counter VAT fraud, and the broad implications for employers and contractors in the construction industry supply chain.
Background to the Consultation document
According to the Consultation document, "organised crime groups are setting up businesses with the intention of fraudulently failing to pay VAT" and "We are currently investigating cases where our estimates of the revenue losses are in the tens of millions of pounds".
In effect, fraudulent businesses are failing to pay over VAT to HM Revenue & Customs (HMRC), in particular those supplying labour (as distinct from labour plus materials).
The government's proposal to introduce DRC
A DRC, as explained below, has been effective in countering VAT fraud in the telecoms (airtime and mobile telephone) and energy sectors, and the government wants to explore the option of a DRC for the construction sector.
What is a DRC?
As the government puts it, "Where a [DRC] applies, the effect is to take VAT payment out of the transaction so the provider of the goods or services cannot disappear or fail to pay the VAT due."
Hence, the essence of a DRC is to transfer the VAT obligations of the (potentially fraudulent) supplier i.e. to pay VAT over to HMRC, over to the (assumed to be honest) customer.
The way the DRC works can be best explained in an example. Suppose a labour only supplier charged £10,000 plus VAT of £2,000 to the main contractor. The supplier will pay over the VAT of £2,000 to HMRC. However, the supplier, if fraudulent, will simply disappear without paying over that VAT (having of course been paid the VAT by the main contractor), in which case the public finances have suffered to the tune of £2,000.
If the DRC were to apply in the above example, the supplier would not charge any VAT to the main contractor, so there would be no VAT to disappear with. But HMRC still needs to be paid that VAT. So, instead, the main contractor, in effect (via appropriate entries in its VAT Return), charges itself ("reverse charges") the £2,000 worth of VAT.
The reverse charged VAT is treated for VAT purposes in exactly the same way as if the main contractor had paid it to the supplier (i.e. as happens at present). Therefore if, (as would normally be the case), the main contractor would be able to recover the VAT from HMRC had it been paid in to the supplier, the main contractor will be able to recover the reverse charged VAT in the same way.
Therefore, the main contractor is not affected financially by the DRC, the only difference being that the main contractor's VAT Return will need to include the extra VAT which it has reverse charged itself.
In effect, therefore, this achieves the government's aim of transferring the VAT risk from a potentially fraudulent supplier to the customer who is assumed to be honest.
So far as the supplier is concerned, it will still have to register for VAT even though it is not charging VAT. So it will remain on the governments radar.
The government raises numerous issues and questions in the Consultation document around the possible introduction of a DRC, amongst which are:
- Should the DRC be limited to the main or principal contractor?
- Should the DRC not apply if the amount of non-labour (for example, materials) exceeds a certain amount of the overall value?
- To what type of services should DRC apply? For example, taking from the definition in the Construction Industry Scheme, the DRC would apply to site preparation, alterations, dismantling, construction, repairs, decorating and demolition.
- Should there be a threshold under which DRC will not apply? For example, excluding small businesses.
Should you wish to respond to the Consultation document, the deadline is 9 June 2017.
Broad implications for employers and contractors in the construction industry supply chain
If the DRC is introduced, on the face of it there should not be too much long term inconvenience for employers and contractors in the construction industry supply chain.
The business to which the DRC applies will need to complete its VAT Returns accordingly; and the supplier to that business will need to be aware that it will have no obligation to account for VAT to HMRC, or indeed to charge such VAT to its customer (its invoices will need to be revised to take account of the DRC).
Conclusion
Both suppliers and customers should be aware of this government consultation and monitor the position in the months and maybe years ahead. Governments of all persuasions are of course committed to stamp out fraud wherever it exists, and therefore it would seem that unless a significant obstacle emerges to the introduction of the DRC, it should be assumed that it will eventually be introduced in some shape or form.
This article is taken from Building Interest - Spring 2017
