V170-840 Reduce VAT fraud
The starting point with any transaction is that the supplier charges VAT on a taxable supply of goods or services made in the UK and accounts for output tax on a VAT return – and hopefully pays this output tax to HMRC.
HMRC has identified that certain supplies have been subject to Missing Trader Fraud, where the supplier charges VAT to a customer and disappears before paying the tax to HMRC on a return. These supplies are often linked to transactions where there is little input tax sacrificed by the fraudulent business ie the “stolen VAT” is sales rather than a margin tax. HMRC has identified that there has been a big tax loss with businesses involved in selling certain construction services.
V170-860 How reverse charge works
With effect from 1 October 2019, the VAT position will change as far as transactions concerning certain supplies of construction services are concerned. From this date, the customer will account for the VAT by doing the reverse charge on his own VAT return. This means that the supplier neither charges VAT to nor collects VAT from his customer. The reverse charge will apply to the following transactions:
- The legislation refers to ‘specified services’ but these do not apply to services supplied to non-construction businesses, such as a high street retailer having his premises improved or any other end user customer or building owner. It is only supplies between construction businesses that are captured;
- The reverse charge will also apply to any goods supplied by the builder as part of his work;
- Employment businesses are excluded from the new rules;
- Supplies between landlords and tenants are excluded from the reverse charge as well as supplies involving connected parties. In such cases, the supplier will continue to charge VAT as happens now;
- The reverse charge will be based on the rate of VAT that applies for the work in question, but only supplies subject to either 5% or 20% VAT.
- The normal tax point rules apply.
- The same principles will apply to retention payments paid to suppliers of construction services ie the reverse charge will apply if the supply relates to a ‘specified service.’
Warning! The reverse charge does not apply to zero-rated sales. This is logical because no output tax is charged on such supplies. Also, note the exclusion above for an employment business. An employment business supplies labour only staff rather than construction services, where the person in question comes under the control and direction of the customer.
Example
Mike is an electrician, VAT registered as a sole trader. He is doing some work on an office block, invoicing the main contractor Steve for his work, who is also VAT registered, and Steve will then invoice the building owner.
In this situation, Mike will not charge VAT to Steve because Steve will deal with the VAT on his own return by doing the reverse charge ie this is a supply from one construction business to another. But Steve will charge 20% VAT on his sales invoice to the building owner because his customer is an ‘end user’ rather than a construction business.
V170-880 Completing VAT returns
Example
Mike from the previous example charges Steve £5,000 for his services, including materials provided as part of his work. The supply is captured by the new reverse charge rules because Steve is not an end user and he is VAT registered. The work carried out by Mike is standard rated.
Mike raises his sales invoice for £5,000 and no VAT.
Mike’s VAT return will make only one entry:
- Box 6 – outputs – £5,000
Steve’s VAT return will be recorded as follows:
- Box 1 – output tax – £1,000
- Box 4 – input tax – £1,000
- Box 7 – inputs – £5,000
Warning! The reason that Steve can enter £1,000 in the input tax box is because the invoice from Mike relates to ‘taxable’ supplies being made by Steve ie the onward charge of his services to the building owner. If the supply related to an exempt supply being made by Steve, then he would be input tax blocked under the rules of partial exemption. In other words, the Box 4 entry of a reverse charge calculation must go through the same partial exemption process as a normal purchase invoice where the supplier has charged VAT.
Warning! The cash accounting scheme cannot be used for a supply of services subject to the reverse charge. This means that the invoice date will be the relevant date for the reverse charge entry by Steve (and the Box 6 entry made by Mike), unless a payment is made in advance of the invoice being raised, in which case the payment date is relevant.
The end result is that the overall figures received by HMRC on VAT returns are unchanged with the reverse charge legislation – all that happens is that the Box 1 entry that would have been recorded by Mike under normal VAT accounting will instead be included on Steve’s return.
Warning! Some businesses will be used to dealing with the reverse charge procedures if they buy services from abroad. But there is a slight variation with the construction industry procedures ie there is no Box 6 entry when a buyer of construction services does the reverse charge procedure, unlike when services are purchased from abroad where entries are made in both Box 6 and Box 7 by the UK buyer.
V170-900 Procedures for suppliers of construction services
- Checks should be applied to ensure that building contractor clients being invoiced under the new reverse charge rules are properly registered for VAT and are bona fide – see VAT Notice 735, section 9.
Warning! If a building contractor does not have a VAT registration number, he should be charged VAT at the normal rate. A customer’s VAT number can be checked at http://ec.europa.eu/taxation_customs/vies
It is suggested that new customers be asked to provide details of their registration as a contractor for CIS purposes.
- Sales invoices should include a reference to ‘reverse charge’ ie so that the customer knows he must account for output tax with the appropriate calculation. The amount of VAT relevant to the calculation should also be shown on the invoice (usually 20% of the invoiced amount or 5% in some cases) or at least the rate of VAT that applies but it must be very clear that the supplier is not charging VAT. Suggested wording in HMRC guidance includes the phrase: “Reverse charge: customer to pay the VAT to HMRC.”
Planning tip – it might be worthwhile for suppliers of construction services to include a statement in their terms and conditions that they will assume a customer is an end user unless the customer says they are not, ie charging VAT at 20% as the starting point. It is up to the customer to inform the supplier that he should not be charged VAT under the new reverse charge procedures.
- HMRC suggest that if there are any doubts about the credentials of a customer, then a deposit equal to the amount of output tax not being charged should be collected from the customer eg if he has applied for but not received his VAT number. VAT Notice 735, para 9.3.1 gives examples of customer checks that should be considered.
- Credit notes – there is no need to adjust VAT if both the supplier and customer agree not to do so – otherwise, the supplier will issue the credit note but the customer will reduce his output tax according to the VAT rate shown on the original sales invoice.
- Flat rate scheme – in most cases, the new changes will only affect the cash flow of a business. This could be important if suppliers have used VAT money in the past to temporarily provide working capital to their business eg collecting VAT from a customer in, say, early January, but not paying it to HMRC until the March VAT return is paid in early May. But there is a potential impact on net profit for a construction business that uses the flat rate scheme (FRS), and benefits from the lower rate of 9.5% that applies if at least 10% of the turnover of a supplier relates to materials.
Example
Pete the Plumber has annual sales on £140,000 plus VAT so is eligible to use the flat rate scheme (the annual joining threshold is £150,000 excluding VAT). All of his work is for VAT registered construction businesses and standard rated and because his turnover from materials is £18,000 plus VAT (ie greater than 10% of total sales), he can adopt the 9.5% FRS rate for ‘general building or construction services’. His total input tax on expenses is £5,000, so his VAT payment with normal accounting would be £23,000 – but with the FRS it is only £168,000 x 9.5% = £15,960 ie gross income multiplied by the relevant FRS percentage.
Reverse charge supplies are excluded from the FRS (VAT Notice 735, para 10.8.1), so Pete’s VAT returns after 1 October 2019 will be nil returns. It would therefore be sensible for him to withdraw from the FRS in order to claim input tax on his expenses ie £5,000 in total. But he will still be £7,040 worse off each year (£23,000 minus £15,960) because he is no longer making a profit with the FRS.
Planning tip – many providers of construction services will become repayment traders with HMRC after October 2019 because output tax will be possibly ‘nil’ but there will still be input tax to claim on eg building materials or overheads. Cash flow could be improved by requesting monthly VAT returns but this will mean submitting 12 instead of four VAT returns each year.
V170-920 Procedures for buyers of construction services
It is important to recognise that the reverse charge applies to “specified services that are reported under the Construction Industry Scheme” (CIS) so, for example, work repairing a roof would be covered but not work repairing a machine in a factory. The new rules also exclude professional services (architects, surveyors etc) and also work installing security systems.
Warning! If there is uncertainty about whether the supply in question is captured by the CIS, then the reverse charge should be applied if the customer receiving the services is VAT registered and payments are subject to CIS. In cases where a sales invoice includes some work that is within CIS and other work that is not, then the reverse charges applies to the full amount shown on the invoice.
It is important that buyers of construction services do not accept an incorrect VAT charge by a supplier – in such cases, HMRC will have the power to assess output tax against the buyer, which means a potential double payment of VAT ie on the builder’s sales invoice and through the HMRC assessment. The onus is on buyers of construction services to make suppliers aware if they are an end user or intermediary supplier. In cases where buyers are end users, HMRC suggests a letter should be sent to suppliers that includes the following statement:
“We are an end user for the purposes of s55A, VATA1994, reverse charge for building and construction services. Please issue us with a normal VAT invoice, with VAT charged at the appropriate rate. We will not account for the reverse charge.”
Warning! HMRC will expect end users to ask for a corrected VAT invoice if the worker incorrectly applies the reverse charge.
Planning tip – it is important that a business buying construction services informs the supplier if they are an ‘end user’ (ie reverse charge does not apply) or an ‘intermediary supplier’ making an onward supply of construction services (ie reverse charge does apply). An end user is defined as a business that “does not make onward supplies of the building and construction services in question”
Warning! If an intermediary supplier is connected to an end user, then the reverse charge does not apply to construction services purchased by the intermediary.
Example
Company A buys construction services and charges connected Company B as an onward supply of construction services. Company B is an end user owning properties that are rented out to tenants. The reverse charge does not apply on construction services supplied to Company A or Company B.
V-170-940 Penalties
HMRC has confirmed that it will apply a light touch as far as penalties are concerned until 31 March 2020: “Penalties will only be considered if you are deliberately taking advantage of the measure by not accounting for it correctly.”