Iain Masterton: Contractors must prepare for potential VAT burden
Accountant Iain Masterton outlines key changes to VAT rules, details why they’ve been introduced and reveals what building contractors must do to ensure they are compliant.
Forthcoming legislation changes could have a major impact on any building contractor business which is registered for VAT and part of the Construction Industry Scheme which supplies its services to larger contractors.
The change is designed to combat fraud in an industry where some firms have set up for only a few months before closing and disappearing with the VAT they owe HMRC. From 1 October 2019, affected businesses will no longer charge contractors VAT on qualifying services. Instead, VAT will be accounted for by the contractor who is receiving the service, using what is known as the ‘reverse charge’ process.
The reverse charge puts the responsibility on to the customer, who must account for the VAT on the supply being made. This reduces the prospect of a supplier collecting VAT from a customer but failing to pay it to the HMRC.
The pending changes will mean that many building contractors which provide a qualifying service to another contractor or construction company will be required to raise invoices without VAT. From 1 October, such invoices should contain all the normal required features of a tax invoice but should also include narrative such as “Reverse Charge: Customer to pay the VAT to HMRC” or “Reverse Charge s.55A VATA 1994 applies”.
The new rules will not affect a contractor’s VAT recovery position as they will still be required to be VAT registered if turning over more than £85,000 per year. They will also still be able to recover VAT on business expenditure.
The value of the supply will still be recorded in Box 6 (Total Sales) of the VAT return. Assuming the invoice was for £1,000, the purchaser will account for £200 VAT in Box 1 of their VAT return and then recover the same amount in Box 4.
The reverse charge will only apply to construction services that are normally subject to the standard rate and reduced rate of VAT. Therefore any building contractor providing services within new zero rated residential property developments will continue to do so. It will also apply to building materials supplied with these construction services.
The measure will only apply to firms that are supplying their construction services to another business that will sell on these construction services. It does not apply where the construction services are provided to a consumer or connected businesses where the normal VAT rules will apply.
It will also not apply to other ‘end users’ including retail, manufacturing, utility, property investment businesses and the public sector – effectively any business which commissions a constructor to have a property developed. In these cases contractors would charge VAT on their invoices as normal. End users will need to make suppliers aware of their status in writing to ensure they are charged VAT correctly. HMRC has provided recommended wording in its guidance issued in June.
I understand they will impose a light touch monitoring regime during the first six months of the changes being implemented to allow for genuine mistakes.
Building contractor businesses should firstly determine whether they will be impacted by this change. They must then identify which services to other contractors will be covered and which services they receive from other sub-contractors might also be affected by reverse charging. Changes to accountancy packages to enable these transactions to be treated correctly from a sales and purchasing perspective will then need to be implemented.
From 1 October, customers will need to be clear in their communications with suppliers during the contracting stage to ensure the VAT status of the works is correct. This will include confirming whether they have ‘end user’ status or not.
A key commercial consequence of this change is its impact on cash flow. Many contractors will raise invoices early in their VAT period, collect the tax and then use this to fund the business until the money must be paid to HMRC one month and seven days after the end of the VAT period. As this will no longer be possible, building contractors must consider the impact on their business and begin planning to offset what could prove to become a significant problem.
Iain Masterton, is head of VAT at accountants Chiene + Tait