The VAT domestic reverse charge: will you be caught out?

12 May 2021

wooden house frames

The VAT domestic reverse charge (DRC) within the construction sector has been introduced with effect from 1 March 2021. Despite pressures from the sector and professional bodies, HM Revenue & Customs (HMRC) resisted calls for the implementation to be postponed again (having already delayed its implementation twice before) or even shelve it altogether.

The DRC is a measure designed to tackle VAT fraud in supply chains identified as being particularly vulnerable to fraud. The measure has already been introduced in other sectors with the same anti-fraud purpose. However, many commentators are sceptical about the potential effectiveness of the DRC with respect to tackling fraud in the construction sector.

What is the domestic reverse charge?

The DRC is a mechanism that shifts the obligation for accounting for VAT on a supply to the customer. Essentially, the customer charges themselves the VAT and pays it to HMRC through its VAT returns. The supplier is therefore not charging or collecting VAT from its customer. In the construction sector, the scope of the DRC covers construction services reportable under the Construction Industry Scheme (CIS), and it applies where services are supplied to parties who are VAT and CIS-registered and who are making an onward supply of construction services to another party.

If the recipient of the service is not VAT or CIS-registered (and is not required to be), and is not making a supply of construction services, it is likely to be considered an ‘end user’. Supplies to end users are not subject to the DRC and normal VAT rules apply.

The impact on landed estates

Some landed estates will need to be mindful of the DRC in the construction sector. However, for the most part, estates will be end users and therefore supplies to them by third party builders or maintenance businesses will continue as normal as far as the VAT accounting is concerned.

Those landed estates that include development companies within their structure may have more to consider.

A CIS-registered development company that is receiving a supply of construction services (subject to the standard or reduced rates of VAT) may not be an end user in these circumstances, unless it is developing for itself. The question to ask would be, is the development company itself supplying a construction service, perhaps as the main contractor, to another party? If it is, and it is VAT and CIS-registered, then the construction services it buys in will be subject to reverse charge VAT and it will have to self-account for the VAT on the supply it has received.

Construction and maintenance services supplied to estates in respect to rental properties will likely be unaffected by the changes. Even in situations where the landlord is deemed to be supplying on a DRC service to the tenant, the fact it has an interest in the same property as the ultimate recipient of the service means the landlord would likely be considered an intermediary supplier to an end user, with normal VAT rules applying in these circumstances.

The end user declaration

Regular suppliers of construction and maintenance services to estates have likely been in touch to ascertain the status of the estate within the construction supply chain and many have been issuing questionnaires in order to gather the appropriate details. Ultimately, if the party receiving services is not CIS-registered and is not making an onward supply, it will be an end user and it must communicate this status to the suppliers in question. This will involve providing a written statement to the effect the supplier should apply normal VAT rules.

Construction Industry Scheme

There are clear synergies between the DRC and CIS, not least the commonality of services which fall within the scope of both. Given that end user status under DRC is, in part, dependent on whether the party receiving a supply of construction services is registered for CIS or not, it is a pertinent time for landed estates to review whether there should be a CIS registration as part of overall tax compliance.

Contractors are obliged to register for CIS. Within the make-up of an estate there may well be a contractor whose business is construction and who pays subcontractors for construction work. Trusts are not considered to be within the scope of CIS and therefore registration for CIS is not required where a trust pays subcontractors.

Development companies within estate structures are likely to be required to register for CIS and to report payments to subcontractors on monthly CIS returns. Deductions from those payments will be required to be reported and paid to HMRC if the subcontractor is registered for CIS under the ‘net’ scheme. The CIS status of the subcontractor would, therefore, determine the nature of the reporting which the contractor is obliged to undertake.

It is fair to say the introduction of the DRC is not a popular one within the sector. In particular, the lack of clarity on certain aspects of the application of the DRC within HMRC’s technical guidance is proving frustrating. HMRC has suggested it will take a light touch in the first six months of the new regime, in terms of any mistakes or misunderstandings. However, what is really needed is comprehensive guidance that can provide comfort that diligent taxpayers are getting it right from the off. In the absence of such guidance, the sector begins accounting for VAT under the DRC with a degree of uncertainty and trepidation and so taking advice from your advisers is all the more important.

Nick Hart, Director