The UK’s construction VAT reverse charge: cash flow issues
First announced in the 2017 Autumn Budget, the construction sector’s VAT reverse charge aims to tackle the issue of ‘missing trader’ fraud. Which reportedly costs HMRC in excess of £100M in ‘lost’ tax revenue each year. Contractors on standard-rated construction projects charge their customers an additional 20% to cover VAT. With a responsibility to then file and pay the tax to HMRC. A contractor supplying a reduced rate service would add 5% to their invoice. If the customer is a VAT registered business. They are usually entitle to reclaim the equivalent amount from HMRC when submitting their VAT return. However, this process has created an opportunity for fraudulent companies to abuse the system by failing to pay the additional VAT over to HMRC.
How will the VAT reverse charge work?
The reverse charge will apply to the whole construction supply chain. Up to the point where the customer receiving the supply is no longer a business. That makes supplies of construction services the end user. There are some limited exceptions for certain intermediaries. The only party in the construction supply chain. Who will charge VAT in the normal way will the main contractor, collecting it from the end user or client and paying it over to HMRC.
The change is significant and affect companies will need to change their systems and processes and train staff. It will also create cash flow issues for suppliers. The changes to the way that VAT is accounts. When a contractor supplies services for a construction project could have a significant impact on its cash flow profile. Currently, many suppliers use the VAT. They pay their customers to fund payments to their suppliers. Until they require to pay it to HMRC with their next VAT return. However, businesses need to prepare for the fact that from October 2020. The payments will receive net of VAT. A failure to consider this could leave them struggling to pay suppliers, and in the worst-case scenario, facing business failure.
Why is this change happening?
The reverse charge aims to combat construction sector fraud. Where suppliers do not account to HMRC for VAT. They have charged to their customers. The new reverse charge means that instead of suppliers collecting cash from their customers in respect of VAT and being liable to pay the VAT to HMRC. Customers will pay the net of VAT amount to the supplier and account for the VAT on their own VAT return. The VAT liability itself is not changing. Only the way it is accounts for.
The reverse charge will affect 150,000 business. There are significant changes to make to IT and accounting systems, staff training, transitioning periods to the new arrangement and, undoubtedly, a negative impact on cash flow. A recent survey by the Federation of Master Builders found that 69% of SMEs were not aware of the pending reverse charge. That of those that were aware only one-third were ready to implement the new system.
However, the reverse charge will not apply to recruitment businesses supplying construction workers. The important distinction between supplying staff and supplying construction services. That’s the individual workers are employed or paid by the employment business and not by the construction business. It uses them to provide construction services.
Moreover, reverse charge VAT is not the solution. A mandatory licensing scheme for UK construction businesses would tackle the root cause of this problem by introducing a minimum barrier to entry. As specialist CIS business accountants, contact us,