Domestic Reverse Charge Explained: What UK Construction Businesses Must Know

The domestic reverse charge is one of the most important VAT changes that has affected the UK construction sector in recent years. Introduced in 2021 as a way to combat VAT fraud, it has fundamentally changed the way VAT is accounted for on certain construction services. For contractors and subcontractors working in construction, it is vital that you properly understand the domestic reverse charge and how it impacts you.

Since it has been implemented, the domestic reverse charge has required more businesses in the UK to review their invoicing processes and ensure they are doing accounting correctly. While the rules can appear complex on the face of it, ultimately they are designed to prevent VAT fraud when the tax is charged by the supplier but then never paid to HMRC.

At Contractwise, we work with companies in the construction industry, helping them with CIS compliance. The domestic reverse charge is especially relevant to this, as it can apply to day-to-day construction transactions.

In this article, we’ll provide you with everything you need to know about the domestic reverse charge.  

Read on for more information…

What is the domestic reverse charge?

The domestic reverse charge is a VAT accounting mechanism that was created in 2021 as a way to shift the responsibility for reporting VAT from the supplier to the customer when it comes to construction services.

Instead of charging VAT and paying it to HMRC, the supplier issues an invoice stating that the domestic reverse charge applies. The customer is then responsible for accounting for the VAT themselves and paying for it on their VAT return.

The main purpose of the domestic reverse charge is to reduce ‘missing trader’ fraud, which was previously a big issue. This is where businesses charge VAT to customers but disappear before paying HMRC. By making the customer responsible for accounting for VAT, the system removes the opportunity for this type of fraud to take place.

The domestic reverse charge typically applies to VAT-registered businesses supplying specified construction services to other VAT-registered businesses where those services will be passed on as part of an onward supply. These specified services generally align with activities covered under the Construction Industry Scheme (CIS). This includes:

• Construction
• Repairs
• Alterations 
• Decorations
• Demoliton 
• Installation services (like heating and lighting)

Importantly, while the customer accounts for VAT, they can also normally reclaim it as input tax under the normal rules. This means that in lots of cases, the transaction is usually VAT neutral for them. 

How does the domestic reverse charge work?

Under the domestic reverse charge, VAT is not charged by the supplier on qualifying construction services. Instead, the customer records the output and input VAT on their own VAT return. This transfers VAT reporting responsibility from the supplier to the customer.

The reverse charge only applies to payments within the scope of CIS, which helps to simplify the process and ensure consistency across the construction sector.

Where construction services are supplied alongside materials as part of a single contract, the reverse charge normally applies to the entire supply. Businesses must carefully assess whether goods form part of a single construction supply or a separate supply that makes it subject to normal VAT rules.

It is important that invoices clearly state that the reverse charge applies and include either the VAT rate or the VAT amount that the customer needs to account for.

What does the domestic reverse charge apply to?

The domestic reverse charge applies broadly across the construction sector. In particular, it is relevant between VAT-registered contractors and subcontractors working on construction services that are covered by CIS.

In general, it applies where construction services are supplied between VAT-registered businesses and the customer is making an onward supply of those services. This means it often applies throughout the construction supply chain, but stops when services reach the final consumer or end user.  

The domestic reverse charge only applies if both parties are VAT registered and the supply is subject to standard or reduced rate VAT. If the customer is not registered, then normal VAT rates will apply instead.  

Exemptions of the domestic reverse charge

There are several key exemptions to the domestic reverse charge. One of the most important is when services are supplied to the end user, like the property owner or occupier, rather than the contractor who is supplying the services.

Other exemptions include when the customer is not VAT registered or when the supply is zero-rated. There is also an exemption for supplies of construction services between group companies. And, when it is in relation to the supplies of staff by an employment business to a construction business, the charge also does not apply.  

The end-user trap

One of the biggest risks surrounding the domestic reverse charge is the end-user trap. The domestic reverse charge end user is perhaps the biggest thing you need to be aware of.

While contractors might know that, from a practical perspective, their customer is the end user, legislation requires written confirmation of end user status before invoices are issued.

If written confirmation is not provided, the supply automatically falls within the reverse charge remit, even if the customer is genuinely an end user. This can cause major complications, including incorrect VAT recovery and even HMRC penalties.

HMRC will not automatically offset VAT paid incorrectly by contractors against VAT recovered by end users. Instead, businesses may need to correct errors separately, which can take a long time to resolve.  

 

Why does it matter how VAT is charged?

Correct VAT treatment is extremely important because mistakes can lead to penalties and corrections that take a long time to resolve. The domestic reverse charge is mandatory for most construction work, meaning businesses must carefully review their transactions to ensure they remain compliant.

If VAT is charged incorrectly, businesses may face inspections and assessments, especially if the proper documentation cannot be provided.

At Contractwise, we can handle all of your CIS tax obligations, protecting contractors and subcontractors and keeping you compliant. We offer a wide range of services, including payroll audits that eliminate the risk of HMRC reclassification. For more information, contact our team today.