The government are introducing Domestic Reverse Charge for construction to reduce VAT fraud within the construction sector. The scheme is effective from 1st March 2021 and is mandatory for most construction businesses. HMRC will collect VAT due on sales directly from the customer, rather than from the supplier.
As well as process changes, the new scheme may have an adverse impact on your cashflow, so it’s vital that you start planning now.
What is the Domestic reverse charge?
A new way for accounting for VAT for businesses who are VAT registered and who operate within the Construction Industry Scheme.
How will it be applied?
VAT will be paid to HMRC by what is classed as the ‘end user’ instead of all the suppliers and subcontractors higher up the supply. When DRC is applied sales invoices will not charge VAT and the supplier will not account for any output VAT in their VAT return.
What is an end user?
They are the final customer, so they do not onward supply any of the building and construction services supplied to them. This applies only to a business or group of businesses that are VAT and CIS registered. You must also consider if the business is connected or linked to the end user, known as an intermediary supplier as this is considered an end user.
In this case the reverse charge is not applied to end users and normal VAT rules will apply.
How will this affect me if I am a supplier / contractor within the CIS scheme and I am VAT registered?
Firstly you will need to check if your supplies fall within the reverse charge services. You must apply the Domestic Reverse charge when you meet all of the following conditions:
- Your business is UK VAT registered.
- Business activity and that of your customer is within the scope of the Construction Industry Scheme (‘CIS’).
- Both your business and your supplier are CIS registered.
- You charge VAT at the standard or reduced rate.
- Customers are not end users.
- You are not ‘connected’ to your customer.
- It is a ‘business to business’ transaction.
The HMRC technical guidance and flowchart is useful.
The DRC applies to me what do I need to do next?
You must consider and implement these steps on as soon as possible:
- Check if your customers are VAT and CIS registered and whether they are an end user
- Check each contract with the customer, as different contracts may need to be treated differently
- Obtain written confirmation from customers if they are an end user
- Check your accounting software for how to apply the DRC – Xero has the tax rates then can be updated
- Update invoices so that the wording and terms correctly apply the DRC when necessary
- Update wording in quotes and terms and conditions
- Carry out a cash flow forecast for the potential impact as you will receive less cash from sales invoices (as no VAT will be applied so 20% less cash received initially). For most this will be a timing difference but if you use invoice discounting this will have a higher impact.
- Consider if you are using the correct VAT scheme as cash accounting and the flat rate scheme cannot be used. If you are likely to be receiving VAT repayments, consider switching to monthly returns.
How do I account for the reverse charge in my VAT return?
For Sales: do not enter any output tax in box 1, include the net sale in box 6.
For Purchases: enter the VAT charged as output tax (but the net purchase is not included in box 6). Reclaim the input tax in same period as per normal VAT rules.
Need help preparing?
We have in-depth knowledge of the construction sector and taxes, and work closely with construction clients every day. As Xero specialists, we can help you set up your billing and show you how to record the checks you’ve carried out. In addition, we can look at the impact of the scheme on your cashflow, and recommend any changes to your VAT scheme.
If you’d like help getting ready, our review will look at the impact of DRC on your business, and provide your action plan.
