The new reverse charge rules for the construction industry were put into place on 1st March 2021. For the construction industry and construction businesses, no matter the size, it is an important change. Understanding what it is and how it can impact your construction business, as well as understanding how it could impact the cash flow of your construction business is important.
Why did the rules change?
The change to the VAT reverse charge rules was brought about because HMRC has evidence that the construction industry is one that is susceptible to fraud. The main area that the new reverse charge rules are set to prevent is missing trader fraud. This is where a subcontractor charges VAT to their clients, but then it disappears after some time of trading. The result of this, and the main reason for the rule change, is that HMRC loses out on the VAT that should be owed from the subcontractor.
By implementing the VAT reverse charge rules from 1st March 2021, it aims to restrict this kind of fraud. Through this, a reverse charge has been put in place. That means that the reporting and the payment of the VAT goes to the client, rather than the subcontractor.
What were the old VAT rules for the construction industry?
Prior to March 2021, the old VAT rules were similar to that of any supply chain. As an example, if the invoice from the construction business subcontractor was for £2,000 plus £400 VAT, then the contractor would be paying £2400 to the construction business subcontractor. Under the new rules, HMRC could be potentially missing out on the £400 VAT payment if the subcontractor was found to be fraudulent or a missing trader.
For the subcontractor completing a VAT return, they would include the amount of VAT, £400, and this would be paid to HMRC. The contractor would have included the amount of VAT, £400, in their VAT return, and as long as there were no other transactions to include, would then reclaim the £400 from HMRC. When put like this, you can see why the new VAT reverse charge rules for the construction industry were put into place by HMRC.
What are the potential problems with the VAT reverse charge for construction businesses?
As with anything that changes, there are likely to be some issues. One of the first potential problems is simply an admin problem. A lot of invoicing and accounting software should be able to deal with the new changes since March 2021, but there could be some teething errors. As there has been the introduction of Making Tax Digital, the majority of VAT registered businesses will be already using software for this. The HMRC example of what should now be on the invoice is:
- Reverse charge: VAT Act 1994 Section 55A applies
One of the other potential issues with the reverse charge rules is that it could create a cash flow problem for many in the construction industry. This is because construction businesses won’t be able to use the VAT that has been received from their customers to use as working capital. As a result, this has the potential impact of many construction businesses working on tight margins which can be difficult when materials need to be bought up-front, for example.
In the past, an invoice could be sent out for £5,000 + VAT. This money will then be paid by the customer in full. The payment and the VAT could have been used as a source of capital until the VAT needed to be paid. Since March 2021, there won’t be any additional VAT from customers for subcontractors to use as capital, therefore reducing the available cash flow.
Monthly VAT returns
There might be some subcontractors who find themselves in the position of not having to charge any VAT on the majority of their invoices. This means that they could become repayment traders. What a repayment trader is, is someone who will receive repayment from HMRC on their VAT returns, typically.
Repayments on VAT could come as a result of the new reverse charge rules. That is why it will be recommended for some construction businesses that apply to move to file their VAT monthly. This will speed up repayments that are due from HMRC and could help with cash flow.
VAT reverse charge and other VAT schemes
The new reverse charge rules for the construction industry will impact some other VAT schemes. Any construction businesses on a Flat Rate Scheme or using something like Cash Accounting, may no longer be beneficial as a result of the new reverse charge rules.
VAT changes for the construction industry
There is no doubt that fraud and in this case, missing trader fraud, is a big problem for HMRC. Through the implementation of these VAT changes in the construction industry, it definitely will help with this problem. What needs to be considered is that the consequences of poor cash flow for smaller businesses could lead to big problems if not accounted for or dealt with well. If this could be a potential issue for your construction business, then you need to think about what options you have. There are options for you, such as:
- Check what VAT scheme you are on. For example, a Flat Rate is a VAT scheme that is unlikely to be favorable as a result of the new VAT reverse charge rules for the construction industry
- Ensuring higher payments from customers by changing to gross status, rather than remaining as net subcontractor status
- Talking about payment terms with your customers so you know what will be paid and when
- Considering changing your VAT returns to monthly VAT returns if the business can become a repayment trader, to improve cash flow
- Choosing to delay your capital expenditure until next year, when their overall impact on your business cash flow will be better understood
For some more information on the new reverse charge rules for the construction industry, you can see the official.