The Construction Industry Scheme (CIS) VAT domestic reverse charge will be introduced on 1 March 2021 for building and construction services in an attempt to combat VAT fraud within the industry.
Normally, fraud within labour supply chains is related to tax, but HMRC have noticed an increase in VAT fraud in large construction projects. This fraud was estimated to have cost the UK Exchequer over £100 million every year.
The measure was initially scheduled to come into force in October 2019 and was delayed by a year due to Brexit. It has once again been delayed by 5 months in order to give businesses time to overcome the effects of the coronavirus pandemic.
The reverse charge means a customer within the construction sector (i.e. business to business) that receives a supply of construction services will have to pay VAT directly to HM Revenue & Customs (HMRC) as opposed to paying it to the supplier.
The reverse charge applies when the following criteria are met:
- The supply for VAT includes construction services and materials.
- The supply is made at a standard or reduced-rate of VAT where payments are required to be reported through the CIS.
- It is made between a UK VAT and CIS registered supplier and a UK VAT and CIS registered customer.
- The customer intends to make an ongoing supply of construction services to another party.
- The supplier and customer are not connected parties.
The following will be excluded from the new rule if the customer notifies the supplier that the exemption applies:
- Supplies made to ‘end-users’ i.e. a VAT registered customer that does not intend to make further on-going supplies of construction.
- Supplies between connected parties e.g. two companies in the same group.
- Supplies between landlords and tenants
- VAT exempt construction services
- Supplies not covered by CIS
- Supplies of staff
In order to comply with the CIS VAT reverse charge, businesses will need to significaly change their approaches. This includes training their staff to recognise relevant CIS contracts ad end-users and modifying accouting and bookkeeping systems to cope with the new invoicing and reporting obligations.
The new measure will significantly impact how businesses comply with VAT and how they handle their cash flow. The VAT Flat Rate Scheme and Cash accounting may no longer be possible and those at the start of the supply chain may become VAT repayment claimants. They should consider filing monthly returns.
An Example of How the CIS reverse charge works
Adam the Floorlayer (who is VAT registered) supplies the materials and lays the flooring for a new office building for Joe the Contractor (who is also VAT registered) and in turn supplies its construction services to Faye the Developer (also VAT registered).
Faye the Developer finds and develops land and will, in this case, bring the build to completion and supply a finished commercial building to her client Danseo, the end-user.
Under the old VAT system:
Adam the Floorlayer would invoice Joe the Contractor £120,000, comprising his £100,000 bill for materials, labour and works, plus £20,000 in VAT (at 20%).
From March 2021, under the new CIS reverse charge system:
Adam should invoice £100,000. His invoice will state that ‘the CIS reverse charge applies’ and that the applicable rate of VAT is 20%.
Joe the Contractor pays Adam the Floorlayer the net £100,000 fee. He then accounts for output and input VAT of £20,000 on the supply on his own VAT return.
Adam does not account for output VAT in his accounting system as he has invoiced only his fee £100,000.
As a consequence of the reverse charge procedure, Adam charges and receives £20,000 less than under the old system (where he would charge £100,000 + VAT). He does not have to account to HMRC for any output tax on the transaction.
When he is paid by Joe, he includes the value of the sale in Box 6 of his VAT Return. He does not add VAT to Box 1 as he receives no output VAT.
The change may well impact Adam’s cash flow, as under the old rules, if Joe the Contractor was a prompt payer he could hope to use the £20,000 in VAT to purchase his materials. He could then purchase his materials and offset the input tax paid against his output liability.
Joe the Contractor has a cash flow advantage. He does not have to pay Adam £20,000 and at the end of his VAT quarter he cannot reclaim £20,000 as he is accounting for the reverse charge and the output VAT offsets the input VAT.
As Joe the Contractor is supplying CIS services, he must also consider the reverse charge. Will his client (Faye the Developer) be involved in the onward supply of CIS services?
In this case, this may be difficult to determine as apparently Faye the Developer is selling a finished building to Danseo as an investor and the reverse charge does not apply. It is Faye the Developer’s responsibility to notify down the supply chain.
What services are within the CIS reverse charge?
- Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures (whether permanent or not), including offshore installation services.
- Constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, including (in particular) walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, docks and harbours.
- Pipelines, reservoirs, water mains, wells, sewers, industrial plants and installations for purposes of land drainage, coast protection or defence.
- Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure.
- Internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration.
- Painting or decorating the inside or the external surfaces of any building or structure.
- Services which form an integral part of, or are part of the preparation or completion of the services described above. This includes 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.
Excluded services
- Drilling for, or extracting, oil or natural gas.
- Extracting minerals (using underground or surface working) and tunnelling, boring, or construction of underground works, for this purpose.
- Manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site.
- Manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to site.
- 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, including burglar alarms, closed-circuit television and public address systems.
Certain services can become included
- If there is an element of reverse charge in a supply, then the whole supply will be subject to the domestic reverse charge.
- If there has already been a reverse charge service between two parties on a construction site, and if both parties agree, any subsequent construction supplies on that site between the same parties can be treated as reverse charge services.
- If there is doubt whether a type of works falls within the definition of a specified service, so long as the recipient is VAT registered and the payments are subject to CIS, the reverse charge should apply.
- The contractor is asked to consider all construction contracts with a subcontractor. If they can see that reverse charge applies to more than 5% of contracts (by volume or value) with that subcontractor, then the reverse charge may be applied to all the contracts.
An example from HMRC
A joiner constructing a staircase offsite and then installing it onsite is making a reverse charge service, even if the charge for installation is only a minor element of the overall charge.
Treatment of existing contracts to be ready for 1 March 2021
The VAT treatment is determined by whether the payment due on supplies is entered in the accounting system before 1 March 2021 and is paid before, on or after 1 March 2021.
| Date entered in customer’s accounting system | Date payment made | VAT Treatment |
| Before 1 March 2021 | On or before 31 May 2021 | Normal VAT rules |
| Before 1 March 2021 | On or after 1 June 2021 | Domestic reverse charge |
| On or after 1 March 2021 | On or after 1 March 2021 | Domestic reverse charge |
For contracts starting after 1 March 2021, you should state whether the reverse charge applies from the start of the contract.
Invoices
When supplying a service that is subject to the CIS reverse charge, the supplier must show all the information that is normally required on a VAT invoice as well as:
- A note on the invoice that makes it explicitly clear that the CIS reverse charge applies and that the customer is required to account for the VAT.
- No VAT is charged on the invoice.
- It should state how much VAT is due under the reverse charge, or the rate of VAT if the amount cannot be shown. This VAT should not be included in the amount charged to the customer.
Under the VAT Regulation 1995, invoices for services subject to the reverse charge where the customer is liable for the VAT must include the reference ‘reverse charge’.
Here are some examples of wording that meet the legal requirement:
- Reverse charge: VAT Act 1994 Section 55A applies.
- Reverse charge: S.55A VATA 94 applies.
- Reverse charge: Customer to pay the VAT to HMRC.
For more advice or help with modifying your bookkeeping in order to comply with the CIS VAT reverse charge, let’s chat.