How does a VAT Reverse Charge on Construction Work?

What is a reverse charge?

Reverse charge, sometimes referred as domestic reverse charge, is a mechanism designed to prevent trader fraud because it makes the customer responsible to account for the VAT and thus leaves no window for the supplier to go missing without declaring and paying the same to the HMRC.

In simpler words, reverse charge is a process in which VAT is charged by the customer themselves instead of the supplier. Value Added Tax, commonly known as VAT, is a tax which is added to certain goods and services. However, not anyone and everyone can add VAT to his invoice. Rather, one need to be VAT registered in order to add VAT to his goods or services.

Reverse charge or domestic reverse charge is only applicable to supply of certain or specified construction services to other businesses in the construction sector.

Also Read: Why Should Register for VAT

How does a Vat Reverse Charge on Construction Work Applicable reverse charge or domestic reverse charges on services, such as:
  1. Construction, alteration, repair or extension, demolition/dismantling of permanent/temporary buildings, including offshore installations.
  2. Decoration of internal or external surfaces of any building or structure.
  3. Internal cleaning of the buildings. However, the cleaning done during the period of their construction, alteration, repair, extension or restoration will only be counted or considered.
  4. Installation of heating systems, lighting, ventilation, air-conditioning, power supply, drainage, sanitation, water supply or fire protection.
  5. All services which are integral part of construction such as clearance of the site, boring and tunnelling, earthmoving, excavation, site restoration, erection of scaffolding, landscaping, provision of roadways etc.

Reverse charge is applicable to those construction services which are subject to standard rate and reduced VAT rate. However, there is a list of certain construction services on which reverse charge is not applicable, such as:

  1. Extraction of natural gas or oil.
  2. Extraction of minerals.
  3. Construction of underground works for extraction of oil or natural gas/minerals.
  4. Manufacture of components for the installation of heating systems, lighting, air-conditioning, ventilation, drainage, sanitation or power supply.
  5. Engineering interior or exterior decoration.
  6. Installation of seating, blinds and shutters.
  7. Installation of security systems such as burglar alarms, closed circuit television or public address systems.
  8. Specified construction services which are not used to make an onward supply of construction services.

Also Read: Pros and Cons of VAT Registration

HMRC draft legislation on reverse charge

HMRC is very clear on the application of reverse charge on specified or targeted construction services i.e. it is strictly applicable to the businesses which supply their construction services to the other businesses who will further sell on the provided services. In simpler words, it is not applicable in the scenario where the construction services are rendered to a consumer of those services. Also, apart from the consumers, developers, property investors, landlord-tenant payments, and any intra-group transactions between connected companies are excluded from reverse charge or domestic reverse charge.

Also Read: HMRC TAX Return

Reverse charge will be in effect from October 2019 and HMRC has published its draft legislation and its final order and guidance is expected to be released by Oct 2018. However, one very important concern has been raised by the British Property Federation and they are of the view that to ensure smooth and effective implementation of reverse charge mechanism, businesses should issue “please don’t charge me” certificate rather than issuing a “charge me” certificate because in later case, it will create a significant administrative burden on the businesses, especially those who are not in the construction sector.

HMRC has kept time of one year i.e. from publishing a draft legislation of the reverse charge till releasing final order and guidance on the same, so that the small businesses get the required time to adapt themselves as per the suggested proposal. Businesses that might get affected by the reverse charge i.e. those who supply construction services need to identify if the services they supply fall under the list of specified services. Because those are the businesses who will no longer charge VAT on their services because under reverse charge, VAT will be charged by the recipients of the services themselves.

Also Read: HMRC VAT Online

Impact on reverse charge mechanism

HMRC acknowledge the impact reverse charge mechanism is going to make on the construction businesses because before the mechanism comes into effect, it is very important that the businesses should work on their accounting process and adapt it for the seamless introduction of the reverse charge mechanism. Apart from changing/adapting their accounting system, some businesses might also face loss of cash flow because since VAT will no longer be charged, they won’t be able to use the same as their working capital. Although HMRC has highlighted the probable problems or concerns and has asked for the expert comments on its draft legislation, however, there are few other important concerns which need to be, or rather should be addressed before the reverse charge is implemented, such as:

  1. In order to see if the reverse charge is applicable or not, certain information, which otherwise could be commercially sensitive information, need to be disclosed.
  2. Since the recipient will become responsible for charging VAT, he will in turn also become responsible to identify the correct VAT treatment for the provided service and in certain cases, to identify the same, might not be an easy task.

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