Reverse VAT

Reverse VAT, officially known as the domestic reverse charge for building and construction services, can cause confusion for contractors and subcontractors.

The main difference from normal VAT is that the supplier does not collect the VAT from the customer. Instead, the customer accounts for the VAT directly through its own VAT return.

The rules are closely linked to the Construction Industry Scheme, commonly known as CIS. However, reverse charge VAT and CIS are not the same system, and each must be considered separately.

What is reverse charge VAT?

Under normal VAT rules, a VAT-registered business charges VAT to its customer, collects the money and pays the VAT to HMRC through its VAT return.

Under the domestic reverse charge:

• the supplier does not collect the VAT;
• the customer accounts for the VAT as output tax;
• the customer will normally reclaim the same amount as input tax, subject to the usual VAT recovery rules.

The purpose is to reduce VAT fraud within construction supply chains. It generally changes who reports the VAT rather than changing the underlying VAT rate.

When does reverse charge VAT apply?

The reverse charge will normally apply when all the following conditions are met:

• The supplier is registered, or required to be registered, for UK VAT.
• The customer is registered, or required to be registered, for UK VAT.
• The payment must be reported under CIS.
• The work is standard-rated or reduced-rated for VAT.
• The customer is buying the construction services to make an onward supply of construction services.
• The customer has not confirmed in writing that it is an end user or intermediary supplier.
• The supply is not simply the provision of workers by an employment business.

The CIS payment status of the subcontractor does not determine whether reverse charge VAT applies. A subcontractor with gross payment status may still need to issue a reverse charge invoice.

What work is covered?

The reverse charge applies to many of the same construction operations covered by CIS, including:

• constructing, repairing, extending or demolishing buildings;
• alterations and refurbishment work;
• electrical, heating, lighting and ventilation installations;
• drainage, sanitation and water systems;
• painting and decorating;
• site preparation and groundworks;
• internal cleaning carried out as part of construction work;
• labour-only subcontracting where the subcontractor remains responsible for completing the work.

Where materials are supplied as part of a construction service, the materials will generally follow the VAT treatment of that service.

Some services supplied on their own are outside the reverse charge rules, including certain professional services provided by architects, surveyors and consultants.

How are reverse charge VAT and CIS connected?

Reverse charge VAT uses the scope of CIS to help determine which construction services are covered.

However, they remain two separate systems.

CIS

CIS determines whether a contractor must deduct tax from payments made to a subcontractor.

Depending on the subcontractor’s HMRC verification status, the contractor may:

• make no deduction under gross payment status;
• deduct CIS tax at 20%; or
• deduct CIS tax at 30%.

The CIS deduction is normally calculated on the labour element after excluding VAT and qualifying materials.

Reverse charge VAT

Reverse charge VAT determines who accounts for VAT on the transaction.

Where it applies:

• the subcontractor does not collect the VAT;
• the contractor accounts for the VAT on its VAT return;
• any CIS deduction is calculated separately.

A transaction can therefore be subject to both a CIS deduction and reverse charge VAT.

Reverse charge VAT example

A VAT-registered electrical subcontractor completes work for a VAT-registered main contractor.

The work is:

• reportable under CIS;
• subject to VAT at 20%;
• being supplied onwards by the main contractor to its customer.

The subcontractor’s invoice could show:

Description	Amount
Electrical installation work	£10,000
VAT at 20% to be accounted for by the customer	£2,000
Amount payable before any CIS deduction	£10,000

The subcontractor does not collect the £2,000 VAT.

The contractor accounts for £2,000 as output VAT and will usually reclaim £2,000 as input VAT, subject to the normal VAT recovery rules. Any CIS deduction is then calculated separately.

What should the subcontractor put on the invoice?

A reverse charge invoice should contain the usual VAT invoice information, but it must also clearly state that the reverse charge applies.

Acceptable wording includes:

Reverse charge: VAT Act 1994 Section 55A applies.

or:

Reverse charge: Customer to account to HMRC for the VAT.

The invoice should show the VAT rate or the amount of VAT that the customer must account for, but the VAT must not be included in the total amount charged to the customer.

The subcontractor should record the net value of the sale in box 6 of its VAT return but should not include the reverse charge VAT in box 1.

What does the contractor do?

The contractor receiving the reverse charge invoice must:

• check that the supplier’s VAT number is valid;
• confirm that the work falls within CIS;
• check that the correct VAT rate has been used;
• check whether it is an end user;
• make sure the invoice states that the reverse charge applies;
• record the transaction using the correct accounting software VAT code.

The contractor normally records:

• the VAT as output tax in box 1;
• the same VAT as input tax in box 4, subject to the usual recovery rules;
• the net purchase value in box 7.

Reverse charge VAT may therefore have no net VAT cost where the contractor can recover all its VAT, but it must still be reported correctly.

What is an end user?

An end user is generally the business that receives construction services for its own use rather than selling those construction services onwards.

Examples could include:

• a retailer paying for work on its own shop;
• a manufacturer extending its factory;
• a business arranging repairs to its own offices;
• a property business receiving services that it does not supply onwards as construction services.

The end user should notify the supplier in writing where it wants normal VAT treatment to apply.

HMRC provides the following type of wording:

We are an end user for the purposes of section 55A VAT Act 1994 reverse charge for building and construction services. Please issue us with a normal VAT invoice.

Without written confirmation, a supplier may need to apply the reverse charge where the other conditions are met.

When does the reverse charge not apply?

Reverse charge VAT will not normally apply where:

• the customer is a private householder;
• either party is not VAT registered or required to register;
• the payment is not reportable under CIS;
• the supply is zero-rated;
• the customer is an end user and has provided written confirmation;
• the supply is made within the same VAT group;
• the transaction is the supply of workers by an employment business;
• the work consists only of an excluded professional service.

Normal VAT rules will usually apply instead.

Common reverse charge VAT mistakes

Charging VAT when the reverse charge should apply

The customer may incorrectly pay VAT to the supplier and then attempt to reclaim it from HMRC.

Where VAT has been incorrectly charged, the customer should normally ask the supplier to correct the invoice rather than simply reclaiming the VAT.

Assuming CIS gross status removes the reverse charge

Gross payment status affects CIS deductions. It does not decide whether the VAT reverse charge applies.

Applying reverse charge VAT to private customers

Private householders are not VAT registered, so construction work supplied directly to them will normally follow the usual VAT rules.

Failing to obtain an end-user declaration

A supplier should obtain clear written confirmation where a customer says it is an end user and expects VAT to be charged normally.

Using the wrong VAT code

Accounting software will normally have specific VAT codes for reverse charge sales and purchases. Using a standard VAT code can incorrectly affect boxes 1, 4, 6 and 7 of the VAT return.

How does it affect cash flow?

Subcontractors whose sales are mainly reverse charged no longer collect VAT from their contractor customers. However, they may still pay VAT on materials, vehicles, equipment and overheads.

This can result in the subcontractor regularly being due a VAT repayment from HMRC. Depending on the amounts involved, moving from quarterly to monthly VAT returns may improve the timing of repayments.

Businesses using the VAT Cash Accounting Scheme or Flat Rate Scheme should also review how the reverse charge affects them, as reverse charge transactions are excluded from those schemes’ normal calculations.

Final thoughts

Reverse charge VAT is not simply a matter of removing VAT from every subcontractor invoice.

Before raising or paying an invoice, businesses should check:

1. Is the work covered by CIS?
2. Are both businesses VAT registered?
3. Is the work standard-rated or reduced-rated?
4. Is the customer supplying the construction services onwards?
5. Has the customer confirmed that it is an end user?
6. Has the invoice been entered using the correct VAT and CIS treatment?

Getting these points right will help prevent incorrect VAT returns, incorrect subcontractor payments and avoidable cash-flow problems.

At GMS Business Accountants, we help contractors and subcontractors understand their VAT and CIS responsibilities, review invoices and make sure transactions are recorded correctly.