The domestic reverse charge for VAT has been talked about for some time, but after a number of delays, has finally come into force from 1 March 2021.
The government has introduced the domestic reverse charge in an attempt to minimise tax fraud in the construction industry, specifically businesses collecting VAT on their sales invoices and then never paying it on to HMRC. The government has always seen the construction industry as high risk which is why the Construction Industry Scheme (or “CIS”) exists. The new domestic reverse charge builds closely on this.
Where the domestic reverse charge applies, the business raising the invoice does not charge VAT in the normal way. Instead, VAT is charged at 0% and the recipient of the invoice is required to both account for the VAT and claim it back. The process is very similar to that which applies when making supplies to a customer outside the UK, or when receiving goods or services from a non-UK supplier.
Where Does the Domestic Reverse Charge Apply?
The starting point is that the domestic reverse charge can only apply where the service being provided is within CIS (the Construction Industry Scheme) AND the customer is registered for CIS. This means that if your business does not make supplies within CIS then you will not be affected by these changes. Also, if your business is not CIS registered then there should be no impact.
It is also the case that the domestic reverse charge can only apply where the supplies are made to another VAT registered business. If the customer is not VAT registered, for example, an individual, VAT continues to be charged in the normal way.
For those businesses which are within CIS, and which make supplies to VAT-registered customers, HMRC has produced two very helpful flow charts which set out when a supply is subject to the domestic reverse charge. One is for sales invoices, one for purchase invoices.
What is an End-User?
There is an exception from the domestic reverse charge where the customer is the “end-user”. This is the case where the customer is a business or group of business that is registered for VAT and CIS but which is not making an onward supply of the services provided to them (because the construction services supplied are for the business’s own use).
This will be the exception rather than the rule and the “end-user” needs to provide confirmation that they are the end-user if the domestic reverse charge is not to apply.
Most customers who might be thought of as “end users” are already outside the changes because they are individuals or non VAT registered. We would stress that VAT continues to be charged in the normal way to individuals and other non VAT registered customers.
My business makes supplies within the domestic reverse charge, how should they be invoiced? Where supplies are within the domestic reverse charge, VAT should not be charged. Instead, the invoice should read “Reverse charge: VAT Act 1994 Section 55A applies” (or similar). This will notify the customer that they need to apply the reverse charge.
We have received an invoice that states “Domestic reverse charge VAT applies”. What should we do? Assuming that the domestic reverse charge is being applied correctly, then the business receiving the supplies needs to charge itself the VAT and also recover it on its VAT return. On an invoice for £5000 which would ordinarily bear VAT at 20%, this would mean the business charging itself £1000 of VAT (box 1 of VAT return) and also recovering £1000 of VAT (box 4 of VAT return).
If the domestic reverse charge has been applied in error, the supplier should be notified and asked to correct the invoice.
What Does it Mean in Practice?
Where a business makes supplies which are potentially within the domestic reverse charge the following will need to be considered:
- Cash flow: many businesses in the construction supply chain have historically used VAT collected on sales invoices to help fund cash flow. This will no longer be possible as they will no longer be collecting VAT on behalf of HMRC.
- Computer systems: businesses that need to apply the domestic reverse charge may need to update their computer/accounting systems to account for these changes. We are able to advise on how domestic reverse charge VAT invoices should be processed through all of the main accountancy software packages.
- Training: in due course, HMRC will inevitably seek to levy penalties where businesses fail to apply the domestic reverse charge, and indeed may seek to disallow the input tax recovery where a supplier has applied the reverse charge in error. For these reasons it is strongly recommended that businesses that are within the scope of the changes make sure that they are aware of when the new rules apply. We have provided a link to the full HMRC guidance and are also able to advise on specific scenarios which you might come across.
See the Reverse Charge Technical Guide