Domestic Reverse Charge for VAT and CIS
If you are involved in CIS (Construction Industry Scheme) either as a Contractor or Subcontractor and are VAT registered, this applies to you. You need to be aware because your invoicing and VAT will change.
Domestic Reverse Charge (DRC) applies from 1 March 2021. There are some terms used which might not be familiar so best to familiarise yourself with the terminology and the process.
The process starts with the Subcontractor. If you are not VAT registered, you can go and have a cup of tea. You don’t have to bother with the rest, but you might find it interesting, particularly if you have plans to grow your business.
There are three things which a subcontractor needs to establish:
Does the work carried out fall within the CIS scheme?
In most cases this will be pretty obvious but there may be areas of doubt. For example, an electrical installation is usually within CIS but repair or maintenance probably isn’t.
If it is something which isn’t within CIS, the normal VAT rules apply. You charge it at the appropriate rate.
It is possible to carry out work on the same premises which might fall into both categories. For example, an electrician does some maintenance work on the electrics in one part of a building, then carries out an installation on another part.
If the work is within CIS, you go on to the next question.
Is the person or company you are doing the work for a Contractor or an End User?
If you are working for an End User, the normal VAT rules apply. You charge it at the appropriate rate.
An End User might be a householder or a company you are doing work for on their own premises. Note that it is possible to be both a Contractor and an End User. For example, if you carry out work for a building company which is going to be invoiced on, they are a Contractor. If you carry out work on their own premises, they are an End User.
Once you’ve established that the work falls within CIS and you are working for a Contractor, you can ask the next question.
Is the Contractor you are working for registered for VAT?
If the Contractor is not VAT registered, the normal VAT rules apply. You charge VAT on your invoice at the rate applicable to the job.
So, you are doing work which falls within CIS, you are working for a Contractor and the Contractor is VAT registered. This is where the DRC (Domestic Reverse Charge) regulations kick in.
DRC is about what you, as a subcontractor, show on your invoices.
Under DRC, your invoice should show 0% VAT – and this applies to materials, travel etc, not just to labour.
On your invoice, you must also state that “Domestic Reverse Charge applies to this invoice and the VAT would be £X” – or something similar.
Note that the construction industry can have three different rates of VAT. Even if it would be zero (new build properties), the statement saying that Domestic Reverse Charge applies must appear.
The Contractor you are working for will pay you after making the appropriate deduction for CIS from the labour part of your invoice. You will be paid in full for parts and materials – excluding VAT.
You record the sale on your VAT Return as being at 0% VAT.
Please note that the Flat Rate Scheme (FRS) doesn’t work under DRC and Cash Accounting for VAT cannot be used.
Cashflow for Subcontractors
One important thing to look out for is the negative effect on cashflow of the changes. Under the current system, a VAT registered subcontractor would charge and receive VAT. This VAT would not need to be paid to HMRC until several months later (possibly up to 4 months) so you, as a subcontractor, would have the benefit of the money in your bank for a period. Under DRC, you will not receive the VAT.
The negative cashflow effect is even worse if you are supplying materials. You will be paying the VAT on those materials but won’t be able to charge the VAT to your Contractor. This could mean that you must wait until you submit your VAT Return (up to 4 months later) before reclaiming the VAT.
For a lot of Subcontractors this change in VAT treatment could mean that they are usually receiving refunds from HMRC – but having to wait for that refund.
One way of improving the situation is to switch to Monthly Reporting for VAT. This means that VAT Returns are submitted monthly and refunds of VAT are also received monthly. Please ask if you are unsure about this.
If you are a Contractor, firstly you will need to confirm your status to any Subcontractors you use. They should ask you whether you are a Contractor or an End User and your VAT status. It would be good practice, and save time, if you made a point of confirming status to Subcontractors on a regular basis, and, preferably, on a job by job basis.
When you receive an invoice from a Subcontractor you must determine the VAT rate applicable to the work carried out. There are three possible rates of VAT depending on the type of work.
Once you have established the relevant VAT on the work, you need to enter it into your accounting system. Most cloud systems will be updating their software to incorporate and correctly record the VAT. If you are using an older, non-cloud, system, there may not be an update so the transaction will need to be recorded manually. Precisely how to do this will vary from system to system so we cannot give a blanket solution. Please ask – or take this opportunity to switch to software which will deal with it.
The result on your VAT Return is that the VAT will be recorded twice – once as VAT reclaimable and once as VAT payable. This will be Net Zero so no VAT to pay.
You will pay your subcontractors in accordance with their invoice (no VAT) and deduct and account for CIS in the usual way. CIS deduction rates can vary so you will need to verify the Subcontractor as normal to establish the deduction rate.
If you operate a self-billing system, as many Contractors do, where you create invoices on behalf of your Subcontractors, you need to ensure that the system takes account of the VAT changes outlined above.
Contractor and Subcontractor
You may be a middle man where you are using Subcontractors to complete work for your customer. Your customer may be another Contractor, higher up the chain, or an end user.
You can, therefore, be both a Contractor and a Subcontractor so you must apply both sets of rules.
Not as complicated as it sounds
It does sound complicated but we don’t think it is much more complex than the current system. If you follow the steps and apply common sense it is logical. Soon it will become second nature.
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