What is VAT domestic reverse charge in the construction industry?

Table of Contents
    Add a header to begin generating the table of contents

    In March 2021, HMRC introduced the domestic reverse charge (DRC) to combat VAT fraud in the construction industry. Under this new rule, the obligation to account for and pay VAT shifts from the supplier to the buyer in construction-related transactions. This significant change aims to ensure better VAT compliance and reduce fraudulent activities in the sector.

    The VAT reverse charge in construction shifts the responsibility of VAT payment from the supplier to the customer. It applies to certain B2B transactions for businesses operating in the UK’s construction industry through the CIS scheme, targeting VAT fraud and ensuring compliance.

    But what exactly does this mean for contractors, sub-contractors, and customers? More to the point, does it apply to all works within construction? This comprehensive blog delves into the specifics of the reverse charge, its implications for different parties, and how a team of professional construction accountants can make it a smooth process.

    Jameco Group are expert in all aspects of CIS accounting. For advice, please get in touch.

    What is the VAT domestic reverse charge?

    The domestic reverse charge is a VAT procedure in the UK construction industry whereby the buyer of construction services is responsible for the VAT instead of the supplier.

    The Domestic Reverse Charge (DRC) primarily applies to VAT-registered businesses engaged in transactions under the Construction Industry Scheme (CIS), altering the traditional VAT payment flow to combat fraud and improve compliance within the industry.

    Why does VAT domestic reverse charge exist?

    Historically, the construction industry was notorious for VAT fraud, with businesses setting up, charging VAT to customers and then vanishing without paying VAT to HMRC.

    The domestic reverse charge combats VAT fraud by shifting responsibility to the buyer, simplifying VAT reporting for suppliers, and plugging loopholes in the Construction Industry Scheme.

    This creates a level playing field for businesses, boosts tax revenue, and benefits businesses through improved cash flow, reduced admin, and better transparency.

    How does the domestic reverse charge work within the construction industry?

    Under the domestic reverse charge, construction businesses must account for VAT slightly differently.

    Instead of the supplier (subcontractor) being responsible for charging and accounting for VAT on construction services, the responsibility falls on the buyer (contractor) to account for the output tax. This gets passed up the supply chain until it reaches the end user.

    Suppliers

    As a UK VAT-registered supplier, when issuing an invoice under the reverse charge, you must explicitly state “Reverse Charge Applies” and remove VAT from the total charge. However, you should still provide your VAT registration number for verification purposes.

    Accounting software like Xero supports the domestic reverse charge, automatically applying it when sales are marked with the DRC tax rate. It’s crucial VAT registered suppliers consult with an accountant specialising in CIS to ensure the correct application of the DRC and to configure any necessary settings in their accounting software.

    Buyers

    The buyer then accounts for the VAT on the invoice as input tax on their VAT return. This means they essentially “pay themselves” the VAT and can potentially recover it later, depending on their VAT status.

    What construction services does reverse charge apply to?

    The Domestic Reverse Charge applies to most standard-rated construction services for businesses registered under the Construction Industry Scheme (CIS), with some exceptions. Here’s an overview of the services to which the DRC VAT reverse charge typically applies:

    Building and Structural Works: This includes the construction, repair, extension, alteration, demolition, or dismantling of buildings and structures, encompassing tasks like exterior decoration and work on offshore installations.

    Works on Land: The DRC also covers construction work on land, such as roadworks, building walls, installing power lines, and similar activities.

    System Installations: DRC also applies to the installation of systems like lighting, heating, ventilation, air-conditioning, power supply, sanitation, drainage, water supply, and fire protection in any building or structure.

    For an exhaustive list and specific details, it is advisable to check Gov.uk directly. This ensures that you have the most current and comprehensive information regarding the DRC VAT reverse charge in the construction industry.

    What is exempt from the reverse charge?

    The reverse charge does not apply to the following:

    VAT-exempt building and construction services: These include services like surveying, installing security systems, valuation, site clearance, estate agency, and architectural services.

    Supplies not covered by the CIS: If a supply isn’t typically subject to the CIS, the reverse charge doesn’t apply.

    Supplies of staff or workers: An employment business providing labour alone is exempt.

    Supplies of materials only: Construction companies providing materials without any accompanying services are not subject to the reverse charge.

    Non-VAT registered customers: If the buyer isn’t registered for VAT, the reverse charge doesn’t apply.

    End-users: VAT-registered customers who aren’t making further construction supplies (i.e., they’re the final consumer of the service) are exempt.

    Intermediary suppliers: The reverse charge does not apply for supplies to intermediary suppliers where they tell their supplier this in writing.

    It’s important to note that while this overview covers key exemptions, it is not exhaustive. Regulations can change, and for specific, up-to-date guidance, consulting with a professional accountant or checking the latest HMRC guidelines is advisable.

    What happens if you don’t comply with the domestic reverse charge?

    Failing to comply with the Domestic Reverse Charge (DRC) regulations in UK construction services can lead to several serious consequences for both suppliers and buyers. Non-compliance may result in HMRC imposing significant penalties, especially when incorrect DRC accounting leads to inaccurate VAT returns.

    Such errors can prompt further investigations by HMRC, leading to administrative burdens and an increased likelihood of compliance audits – situations any construction firm would prefer to avoid.

    In the worst-case scenario, non-compliance with the DRC can tarnish a business’s reputation and jeopardise future contracts, particularly with existing clients.

    Firms in the construction sector must understand and adhere to DRC regulations to avoid these detrimental outcomes.

    How can Jameco Group accountants help your construction business?

    Jameco Group can handle your day-to-day accounting and bookkeeping, freeing up your time and ensuring financial accuracy. This is crucial for complying with construction industry regulations and maintaining good cash flow.

    As CIS experts, we understand the unique challenges your business faces. We can tailor our services to your specific needs and handle construction industry-specific taxes like CIS and VAT reverse charges, ensuring you don’t miss deadlines or make costly mistakes. Get in touch with us today.

    Frequently asked questions about VAT domestic reverse charge

    What is the difference between the Domestic Reverse Charge (DRC) and the Construction Industry Scheme (CIS)?

    The Domestic Reverse Charge and the Construction Industry Scheme are distinct mechanisms within the construction sector, each serving a different purpose. CIS is a tax deduction scheme where taxes are deducted from payments made to subcontractors and directly paid to HMRC. It’s essentially a way of collecting income tax from subcontractors in the construction industry.

    On the other hand, the Domestic Reverse Charge relates specifically to how VAT is accounted for in construction services. Under this system, the responsibility to account for VAT shifts from the supplier to the customer. This change primarily targets VAT fraud prevention.

    The connection between CIS and the Domestic Reverse Charge lies in their application criteria: The VAT Reverse Charge generally applies to transactions between VAT-registered businesses under the CIS scheme, with certain exceptions.

    Despite their differences, both schemes are integral to the financial and tax processes in the construction industry, each playing a role in ensuring tax compliance and reducing fraud.

    What if I use the VAT Flat-Rate Scheme?

    Supplies subject to the VAT reverse charge are not included under the Flat Rate Scheme. If you’re using the Flat Rate Scheme and receive a VAT invoice with a reverse charge, you must account for the VAT due to HMRC directly on your VAT return and recover it simultaneously on the same return.

    When making supplies that fall under the reverse charge, Flat Rate Scheme users should not count these supplies’ value in their Flat Rate Scheme turnover calculation.

    What is an end-user?

    End users are not typically registered for VAT under the Construction Industry Scheme. They don’t use the goods and services from construction companies to provide similar services to others, they are the ultimate consumers of the services.

    For example:
    Occupying a building: A business hiring a contractor to build or renovate their office premises.
    Running their business: A company engaging a subcontractor to install a new heating system in their factory.
    Personal use: A homeowner contracting a builder to extend their kitchen.

    What if I’m invoicing for material and labour that includes a VAT reverse charge component?

    If the labour portion of an invoice, which falls under the Construction Industry VAT reverse charge rules, represents 5% or less of the total invoice value then normal VAT rules apply. In such cases, the VAT reverse charge is not utilised.

    If however, it was the other way round, and 5% or less of the total invoice value represented materials and the remaining 95% or more is labour under CIS, then the reverse charge applies to the entire invoice, not just the labour element.

    Do my invoices need to indicate the domestic reverse charge?

    Yes, as well as all the information on a normal VAT invoice, you need to include a statement such as “Reverse charge: VAT Act 1994 Section 55A applies”. While you should exclude VAT from the final amount, you must demonstrate how much VAT is due under the reverse charge.

    James Wheeler, founder and managing directors of Jameco Group
    James Wheeler

    James has over 10 years of experience in accountancy and taxation. He has a real passion for business and truly believes SMEs are the heart of the UK economy. In 2017, he founded Jameco Group to provide first-class accountancy, taxation, and business advisory services to individuals and SMEs across the UK.

    Request a Callback

    Fill out the form below and one of our team members will call you back about your query…

    Let's Work Together!

    Whether you’re requesting a quote or you just have some questions, feel free to get in contact with a member of our team. Please complete our website contact form for a message or call back. We aim to respond quickly.