The Scottish construction industry faces potentially serious cash flow problems under new legislation being introduced later this year.
HMRC’s new VAT domestic reverse charge legislation aims to tackle VAT problems in the construction industry in a similar way that they have addressed carousel VAT fraud in the mobile phone and computer chip sectors.
The new rules come into force on 1 October 2019 and will cover construction services and associated materials supplied as part of the contract terms. Under the new regime, a VAT-registered business, which supplies certain construction services to another VAT-registered business for onward sale, will be required to issue a VAT invoice stating that the service is subject to the domestic reverse charge.
The reverse charge will specifically apply to those supplies made which also require payments to be reported through the Construction Industry Scheme (CIS).
The company receiving the specified services will be required to account for the VAT on the specified services itself through its VAT return at the appropriate rate, instead of paying the VAT due to the supplier, as occurs under the present system. The recipient may then recover this same VAT amount as input tax in the same VAT return period, subject to the normal rules.
The new domestic reverse charge will apply to business-to-business suppliers of specified services between VAT registered businesses where the recipient will make an onward supply of those same construction services. The legislation is designed so that if there is a reverse charge element in a supply then the whole supply will be subject to the domestic reverse charge.
The new rules will not apply where:
– Services are supplied to the end user, such as the property owner; or directly to a main contractor that sells a newly completed building to the customer.
– The recipient makes onward supplies of those construction services to a connected company; the supplier and recipient are landlord and tenant or vice versa.
– The supplies are zero-rated.
The new regulations have been extended from labour only construction services, to include the provision of services with materials, which brings considerably more construction businesses into the reverse charge.
HMRC has acknowledged that the impact on the industry is potentially significant as construction businesses must adapt their accounting systems to process the reverse charge and may experience substantial cash flow issues, as they will no longer be able to use the VAT they collect from customers as working capital prior to it being paid over to HMRC.
Further problems these changes could create include the requirement for the recipients of the supply to identify the correct rate of VAT applicable; contractors to disclose potentially commercially sensitive information to subcontractors over whether they are the at the end of the supply chain; and if this is not disclosed, the end user will become responsible for accounting for the domestic charge.
In order to reduce the potential impact these changes will have on construction businesses they should review supplies made to and received from other VAT registered contractors to establish whether these will be subject to a reverse charge from October 2019; consider the adaptions that will need to be made to their accounting systems to deal with this change and; consider the impact on their cash flow from October 2019 of not receiving the VAT from their customer and consider if there are any ways to mitigate this impact.
These changes have the potential to cause serious financial disruption to many construction businesses, some of which may already be facing cash flow issues and financial hardship.
While these regulations make sense in order to combat VAT avoidance, they are placing a much greater responsibility and liability upon the construction companies to ensure that they identify whether they are liable, that they pay the right amount at the correct rate and the potential impact this may have on their cash flow.
It would be a tragedy if honest, law abiding construction firms were put into financial difficulties implementing a policy aimed at rooting out unscrupulous VAT evaders.
