VAT: reverse charge for construction services

Gavin Birchall, Tax Partner at Scrutton Bland looks at a new initiative designed to prevent fraud in the construction industry.

It’s all change in the VAT world. Making Tax Digital is about to come into force and October this year will see another major shakeup of VAT rules aimed at the construction industry. According to Her Majesty’s Revenue and Customs (HMRC), large numbers of labour-only subcontractors are committing a major fraud known as the Missing Trader Fraud, which is costing the Exchequer an estimated £100 million a year. The perpetrators charge the customer VAT and liquidate their company without paying the collected tax over to HMRC.
 
To prevent this perceived loss of tax revenue HMRC has decided to make the customer, ie the person hiring the labour, rather than the supplier, responsible for tax accounting.This means that the customer will no longer pay the VAT charge to the supplier but will instead include it on their own VAT return as both ‘output’ and ‘input’ tax. This should eliminate the ability of the fraudsters being able to claim cash VAT refunds where the supplier fails to pay VAT to HMRC.
 
The new rules will apply to the standard (20%) and lower (5%) rated supplies of ‘construction services’. Construction services are defined in the same way as the current definition within the construction industry scheme (CIS). So if a contractor or subcontractor is already within the CIS, it is safe to assume that they will also need to follow the new reverse charge procedure.Certain activities are specifically excluded, including professional services, manufacturing, delivering equipment or materials. Unlike the CIS there are no provisions to extend the changes to so called ‘end user’ businesses which commission large construction projects, eg retailers occupying significant real estate.
 
The view of Gavin Birchall, Tax Partner at Scrutton Bland who regularly advises clients in the construction industry is that: “A few complications will naturally arise.For instance, there is no segregation of labour and materials as currently under CIS.The draft legislation requires that any goods supplied within the “construction services” should be treated as part of a single supply of services. Having defined which services are construction services and which services are specifically excluded, the draft legislation goes on to say that whenever excluded services and construction services form a single supply, they will be subject to the reverse charge procedure.”
 
VAT liability is generally determined by reference to a “supply”. A supply can include several transactions, or sometimes a transaction can include more than one supply. VAT legislation does not prescribe what should be done in every eventuality and HMRC do not offer much guidance on the matter and merely observe that 'there is no simple, single answer as to whether a transaction comprises a single supply or several different supplies — the answer will always depend on the facts of each case. The decision will be a matter of judgement based on an objective assessment of all the facts and circumstances.'

The flowchart below illustrates potential areas of difficulty in relation to contractual arrangements observed in the construction industry supply chain.  The transaction flows highlighted in red were perceived by HMRC as open to the missing trader fraud and transactions highlighted in green were generally excluded from the scope of CIS and the new reverse charge rules.  However there are some grey areas.  For example, a project manager providing professional services can bring along a subcontractor.  Now they have to apply the reverse charge procedure, but how are they supposed to know whether or not their client is also supplying “construction services”?

For more information
If you would like to find out more or discuss this further, please conatct Gavin Birchall on 0330 058 6559
Email Gavin