Reverse Charge VAT: Bulletin
January is often a quiet time when thoughts turn to the year ahead. And so what better way to spend your January down-time than by planning for the arrival of reverse charge VAT on 1 October 2019. To many suppliers and recipients of construction services in the industry reverse charge VAT will represent a major change to their accounting and administrative processes and one which will be underestimated or ignored at their peril.
What is Reverse Charge VAT?
The reverse charge mechanism has been implemented under Section 55A of the Value Added Tax Act 1994 (“VATA”) by way of the Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) Order 2019 (draft order). N.B. Even though it is stated to be in draft, HMRC has confirmed that the order is in fact in final form.
Under normal VAT rules, it is the supplier of goods or services who is required to account for VAT on those supplies. However, the reverse charge system requires the recipient, not the supplier, to account for and pay tax on the supply of any construction services (“construction services” is broadly defined under the draft order and will cover most traditional construction works and services with a few exceptions).
Why is it being introduced?
HMRC is attempting to reduce the amount of avoidance of VAT occurring at the lower end of the construction chain where suppliers charge and collect VAT but fail to account for that VAT to HMRC (such as “missing trader fraud”). The logic being that those parties further up the chain are easier to trace and often have better administrative processes to deal with the accounting and due diligence requirements of the VAT system. Such parties are also likely to have more to lose if found guilty of VAT fraud.
How it works
Each party who is supplying construction services to a VAT registered recipient who intends to use those services for making further supplies of such construction services, must reverse charge VAT due to be applied on those services. Conversely, suppliers must not apply the reverse charge if either:
- its customer is not VAT registered; or
- its customer is VAT registered but the customer is not going to use the supplied services for making further supplies (i.e. is not going to operate the CIS scheme on the payment).
Effectively, this means that only contractors who supply to:
- end users (who are not VAT registered); and/or
- contractors who are not required to report payment under CIS
will need to charge VAT to its customers and account to HMRC for that VAT. Whereas those suppliers further down the chain that are caught by the reverse charge will still need to show the nominal VAT on their invoices but will not need to pay any VAT to HMRC because it will be reversed charged to the recipient of its services.
What happens if you or your suppliers/recipients get it wrong?
HMRC has reassured that it will operate a light-touch approach to penalties for genuine mistakes for a six-month period. Despite that, the following key principles apply:
- Under Section 55A(7) VATA 1994 the recipient of a reverse charge supply is responsible for accounting for VAT on the supply to HMRC, therefore any debt will be enforced against the recipient rather than the supplier and any failure by such recipient to account for the reverse charge could result in the recipient being assessed for the supplier’s output tax, losing the right to deduct input tax and also liable for penalties and interest.
- If a supplier incorrectly charges VAT when the reverse charge applies the recipient will be assessed for that output tax and then the supplier will have to return the money collected as VAT and make the appropriate amendments to VAT records and returns. This could also give rise to penalties.
- Recipients who fail to account for VAT where the reverse charge has been correctly applied or who knowingly claim “end user” status when the reverse charge should have applied will still be liable for the output tax that should have been paid and may be liable for penalties. HMRC will not seek to recover the output tax from the supplier as long as the supply undertook reasonable checks of the VAT registration status of the recipient.
- Cash flow: businesses should consider the effect on their cash flow of not receiving VAT from customers and if there are other ways to mitigate this.
- Existing contracts: consideration should be given to both draft and existing contracts which may be in place after 1 October 2019 to ensure that the terms relating to charging VAT comply with Section 55A VATA. The HMRC guidance note states that end users should provide written confirmation of end user status.
- Invoicing and due diligence: ensure that VAT is not being incorrectly charged by performing due diligence on the VAT/CIS status of each customer and supplier. Invoices need to be marked clearly to include the amount of VAT due (although this should not be shown as VAT charged) and a reference to Section 55A VATA (reverse charge) should be added.
- HMRC Guidance Note: HMRC has also published a guidance note, click here to access it.
Sintons LLP do not provide tax or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax and accounting advisors for further advice and information.