What is Reverse Charge VAT?

The introduction of the VAT domestic reverse charge represented a significant shift in how VAT is accounted for in the UK’s construction industry. In the past, suppliers in the sector added VAT to invoices and then paid that VAT directly to HMRC. However, this all changed when the reverse charge scheme was introduced in 2021. It has been designed specifically to tackle the widespread issue of fraud in the building and construction industry.

This means that for contractors and subcontractors, especially those operating under the Construction Industry Scheme, or CIS, understanding how the new VAT reverse charge construction regime works is essential in order to stay compliant. At Contractwise, we’re specialists in CIS compliance, offering payroll audits that protect contractors and subcontractors and eliminate the risk of HMRC reclassification.

In this article, we’ll take a closer look at what reverse charge VAT is and how it works.

Read on for more information…

What is reverse charge VAT?

At its core, the reverse charge VAT mechanism flips the responsibility for reporting VAT from the supplier to the customer. Under these rules, when one VAT-registered business supplies construction materials or services to another VAT-registered business, it is now down to the customer, not the supplier, to account for VAT when paying HMRC.

This does not mean that VAT has disappeared in these transactions, but instead of the supplier paying it, the recipient needs to declare and pay it. It can sometimes be reclaimed as input tax, which in many cases means it ends up being a net zero payment.

This change was introduced in 2021 as a way to root out missing trader VAT fraud, where some businesses previously charged VAT and then disappeared without paying it to HMRC.

When must you use reverse charge VAT

You must apply the reverse charge VAT when:

• Both the supplier and customer are UK VAT-registered
• The services supplied are building and construction-related and reported within CIS
• The services are standard-rated or reduced-rated

Services where reverse charge VAT must be applied include:

• Constructing, altering, repairing, extending, or demolishing buildings or other structures
• Constructing, altering, repairing, extending, or demolishing any works forming part of the land, including walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours, pipelines, water mains, wells, sewers, reservoirs, and industrial plant and installations for land drainage, protection or defence   
• Installing heating, lighting, air conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in buildings or structures
• Internal clearing of buildings and structures as part of a construction project
• Painting or decorating the inside of any external surface in a building or structure
• Services which form an integral part of the preparation or completion of services such as site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works

When you must not use reverse charge VAT

The VAT domestic reverse charge should not be applied for these services:

• Drilling or extracting oil or natural gas
• Extracting minerals and tunnelling, boring or construction of underground works
• Manufacturing, building or engineering components or equipment, materials, plant or machinery or delivering any of these to sites
• Manufacturing components for heating, lighting, air conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to sites
• The professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants
• Making, installing and repairing artworks such as sculptures, murals and other items that are purely artistic
• Signwriting and erecting, installing and repairing signboards and advertisements
• Installing seating, blinds and shutters
• Installing security systems such as burglar alarms, closed-circuit television and public address systems  

What did the reverse charge VAT change?

Prior to March 2021, suppliers of construction products and services charged VAT on their invoices as usual. Under the VAT domestic reverse charge, VAT is still part of the process, but the way it is reported and paid has changed.

Instead of sending VAT collected from the customer to HMRC, the suppliers instead issue an invoice that states the customer needs to account for this charge.

In practice, this means:

• Suppliers do not include VAT on invoices for specified construction services between VAT-registered businesses.
• Recipients must account for VAT on their VAT return. They can simultaneously reclaim it, subject to the normal tax rules.  
• It removes the opportunity for fraudsters to collect VAT from customers and then not pass it on to HMRC.

Reverse charge rules when making sales

When you sell construction services that fall under the domestic reverse charge, you will follow this process:

1. Confirm your customer’s VAT statusand whether they are CIS registered
2. Issue an invoice that clearly states the supply is subject to the domestic reverse charge
3. Do not collect VAT from the customer

Making mistakes here can lead to errors in VAT returns and result in HMRC investigations, so it’s important to get it right.

Reverse charge rules when making purchases

When you buy construction services that fall under the VAT reverse charge, the following will apply:

1. Ensure the supplier has issued a correct reverse charge invoice
2. On your VAT return, account for the VAT payment
3. Claim the input VAT subject to the usual tax recovery rules
4. Use the correct accounting period, which is linked to the invoice

While this process might seem complicated, in effect it means that VAT is payable and reclaimable in the same period. Often, this means tax becomes net zero.

The VAT domestic reverse charge has transformed how VAT is handled in the UK construction industry. While its main aim is to reduce fraud, it also adds a more complex aspect to VAT accounting. This means that seeking expert support for all tax compliance is crucial. At Contractwise, we’re experts in all aspects of tax in the construction industry. In particular, we offer a wide range of services to support with the Construction Industry Scheme (CIS). For more information, contact our team today.