In response to so-called "missing trader fraud" when VAT is collected by criminal businesses set up for the purpose but then not paid over to HM Revenue & Customs (HMRC) in the UK (which is said to cost EU revenue authorities around €60 billion annually in tax losses), the government is introducing a VAT "reverse charge" procedure for construction services supplied in the UK.
The impact on affected businesses is likely to be significant in terms of time and cost. It is important to be aware of this issue and to make a start on preparations in readiness for the changes which will take effect as from 1 October 2019.
HMRC has recently published draft legislation for comment. A final version plus official HMRC guidance will be published before October 2018. The long lead time looks generous, but even HMRC anticipates that there may be difficulties in setting up processes to adapt to a new regime which is the polar opposite to that which the industry has followed since VAT was first introduced.
What is the "reverse charge" procedure?
The essence of the reverse charge procedure (RCP) is to transfer the VAT obligations of the supplier of construction services (i.e. the potentially "missing trader") to the (assumed to be honest) customer. This is best explained in an example:
A sub-contractor carries out £10,000 worth of work for the main contractor. Absent the RCP, the sub-contractor will charge VAT of £2,000 to the main contractor and pay over that VAT to HMRC. However, the sub-contractor, if a "missing trader", will simply disappear without paying over that VAT (having of course been paid the VAT by the main contractor). In that case, the public finances have suffered to the tune of £2,000.
If the RCP applies, the sub-contractor will 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, under the RCP, the main contractor charges itself ("reverse charges") the £2,000 worth of VAT. This is done via appropriate entries in its VAT Return. The reverse charged VAT is treated for VAT purposes in exactly the same way as if the main contractor had paid it to the sub-contractor (as happens at present). If the main contractor is eligible to recover the VAT from HMRC in the normal way, the main contractor will still be able to recover the reverse charged VAT. The main contractor is not affected financially by the RCP, the only difference is that the main contractor's VAT Return will need to include (and also if possible recover) the extra VAT which it has reverse charged itself.
The draft legislation
The draft legislation is fairly straightforward. It simply adds construction services to the current list of goods and services to which the RCP applies. There are some exceptions to the general rule and the RCP does not apply to zero rated services, such as new-build residential developments.
The RCP is restricted to "construction services"
"Construction services" is very widely defined, and is based on the definition already used in the Construction Industry Scheme (CIS). If an employer is within CIS, it is highly likely that he will also need to operate the RCP.
Construction services include construction, alteration, repair, extension, and the demolition or dismantling of buildings or structures, as well as corresponding civil engineering works. Technical services, such as the installation of building systems and services are also included. However, the definition excludes professional work of architects or surveyors, or of consultants in building, engineering, interior or exterior decoration or in the laying-out of landscape (unless supplied as a component of a single supply of construction services).
The mere supply of goods does not comprise construction services, unless supplied as a component of a single supply of construction services. For example, the supply and installation of windows will be construction services, whereas a supply of windows only will not.
Exceptions to the general rule
The aim of the exceptions to the general rule is to exclude certain end users from the RCP. In broad terms, the draft legislation excludes supplies:
- To customers who are not construction businesses, where the works will be used by the customer for any purpose other than making further supplies of construction services. For example, if a contractor is carrying out works for an unconnected retailer, the retailer will not operate the RCP, and the contractor will account to HMRC for VAT in the normal way;
- where the onward supplier to the end user and the end user are legally connected; and
- if there is a landlord and tenant relationship (including licenses). For example, where a landlord employs its tenant as main contractor to carry out a refurbishment of its premises.
How will the RCP affect particular parties?
Main contractor (MC)
The RCP position is as follows:
Works carried out by the MC – the RCP will not apply since the works are carried out for the end user. The MC will therefore account to HMRC for VAT on its works as normal.
Works carried out by the MC's immediate sub-contractor(s) – the RCP will apply (unless one of the exceptions applies). The MC will account to HMRC for VAT on the works carried out by its immediate sub-contractor(s). If the MC is carrying out new build works for a housing provider, the RCP will not apply to the works carried out by the MC's immediate sub-contractor(s) to the extent that those works are zero rated.
Section 106 works on other's land
If the MC is carrying out Section 106 works on other's land, the RCP will not apply to the works carried out by the MC if the MC is not paid for such works. If the MC is paid, the RCP will not apply since the works are carried out for the end user. The MC will account to HMRC for VAT on its works. In any event, the RCP will apply to the works carried out by the MC's immediate subcontractors, unless and to the extent that those works are zero rated.
Landowner (for sale/rent) (Owner)
If the Owner employs a contractor to build a new development (or refurbish an existing development) intended for sale or leasing by the Owner, the RCP will not apply and the contractor will account to HMRC for VAT in the normal way.
Modular supplier (i.e. goods only) (MS)
If the MS supplies modular construction materials to others, the RCP will not apply and the MS will account to HMRC for VAT on its sales in the normal way.
What next?
Construction businesses should not delay taking the steps they need to comply with the RCP. Whilst HMRC have offered "support, including guidance" for all businesses to be affected by the RCP and a "light touch on genuine mistakes and penalties" for 6 months after the RCP comes into force, this "softly, softly" approach will not last. So be aware: VAT errors can have significant and long term financial consequences and is not something to get wrong.
This article is taken from Building Interest - Summer 2018.
