DRC – new VAT rules for the construction sector
Jul 12, 2019
Under new rules due to come in on 1 October 2019, builders, sub-contractors and other trades associated with the construction industry will have to start using a completely new method of accounting for VAT.
HMRC is introducing a ‘domestic reverse charge’ (DRC) for building services, which is intended to ensure that VAT is correctly accounted for on supplies by sub-contractors. This is part of the government’s continued attempt to clamp down on VAT fraud – construction is considered a high-risk industry, as large amounts of VAT are lost to HMRC through trade supplies made with minimal input tax but significant output tax.
What is the domestic reverse charge?
The domestic reverse charge is a fundamental change to the way VAT is collected in the building and construction sector. It will effectively operate as an addition to the Construction Industry Scheme (CIS). Under the new rules, if you are an individual or a business registered for VAT, and you supply standard or reduced-rated building services reported under CIS, you will no longer invoice for VAT. Rather than a main contractor paying you VAT as their supplier, they will instead pay it directly to HMRC. The main contractor will account for VAT on the net value of your invoice, and at the same time deduct the VAT due on the supply as input VAT.
Note that the DRC doesn’t apply if the service is zero-rated, or if the main contractor is not registered for VAT. It also doesn’t apply to domestic customers or end users, such as private individuals, landlords and retailers.
An important point to note – the value of the reverse charge supplies don’t count towards your VAT registration threshold. So if you’re not already registered for VAT then any application of the reverse charge won’t push you over the VAT limit.
What effect will the DRC have on your business?
The DRC will apply to both labour supplies and materials. It means that your VAT accounting systems and software will need to be compliant with applying the reverse charge, and you’ll also need to carry out various checks to ensure the status of your customers. You’ll need to verify:
- Is your customer VAT registered?
- Is your customer CIS registered?
- Is your customer an end-user or an intermediary supplier?
You’ll also need to check whether the DRC affects not just the sales you make, but also the purchases. And you must make sure that you inform your customers and suppliers if and when the reverse charge applies.
Another consideration is whether the DRC will have a negative effect on your cashflow. There will no longer be the opportunity to use the VAT payment received from a customer, in the time before it has to be paid over to HMRC. This may mean that there are benefits of changing from a quarterly to a monthly VAT return cycle, so that you can speed up any payments due from HMRC. Reverse charge transactions cannot be processed through the Cash Accounting Scheme, so the VAT Flat Rate Scheme may no longer be beneficial.
How do you invoice under the DRC rules?
In order to invoice correctly under the new DRC rules, you need to clearly specify on your invoices that the domestic reverse charge applies and that the customer must account for VAT. Even if you are no longer charging the customer for VAT, you must still state the amount of VAT which is due – but don’t include it in the amount shown as ‘total VAT charged’.
If you don’t comply with the DRC rules from 1 October 2019 then HMRC will issue you with a fine. However there will be a ‘soft landing’ period for six months after this date if businesses make genuine mistakes in their efforts to comply with the new system.
Full guidance is available on the Gov.uk website, including all the services affected and excluded by the DRC, plus further information on changing VAT treatment during a contract, completing VAT returns and how to verify the status of your customers.
Please contact us if you are likely to be affected by these changes and we can work with you to ensure you are ready for the new system.