The Domestic Reverse charge is a big shake-up of how the construction industry deals with VAT payments. It has been on the cards for some time, and after it was delayed in 2019, it came into force from March 1st 2021. As tends to be the case with all things VAT related, there is a lot of jargon and legalese in the official releases about how it works. Essentially though, it is much simpler than it initially sounds. However, there is a real danger of some cashflow problems emerging as the system embeds. So, let’s take a look at what it is and then how it could cause a cashflow problem.
Why did they introduce the Domestic Reverse Charge?
It is really all about fraud prevention. A technique known as “missing trader” fraud can be used to gather high amounts of VAT from a customer but with no intention of ever paying that to HMRC. There are several versions of this method of fraud, but they all involve a series of purchases, with some companies claiming VAT back and some not paying the VAT claimed to the government. Essentially, somewhere in the chain of payments and claims, a trader goes missing, and VAT is not paid. The Domestic Reverse Charge is designed to counteract this type of scam by making the contractor responsible for reporting the VAT obligation to HMRC rather than the subcontracting supplier.
Who does it affect, and how does it work?
The new rules are very specific about who needs to be aware of the system.
- Anyone who receives or supplies construction services
- Report under the Construction Industry Scheme (CIS)
- Are VAT registered
If the above applies to you, which is likely to be most contractors and subcontractors, you should be using the Domestic Reverse Charge as of this month.
What this means is a sort of reversal of the way VAT is assessed.
From now on, if you are a contractor and CIS registered, when you receive a bill from a CIS subcontractor, you will be responsible for recording the input and output VAT.
If you are the subcontractor, you will no longer be allowed to charge VAT to your customers if they are a CIS registered business. You will provide the information they need to inform HMRC of the VAT. That means you will essentially receive a lower payment in the short term.
Probably the most urgent data to have then is who in your supply chain the Reverse Domestic Charge applies to. Once you have this information, you will need to make sure that all ongoing transactions meet the needs of the new rules. As with all VAT related systems, there will be some pretty hefty penalties for getting it wrong.
What are likely to be the practical problems?
The obvious one is the need to adapt invoices and other related services to the new system. If you are doing this manually, it means additional training, but, as with most businesses, if you are doing it electronically, you need to make sure your accounts package is capable of handling it and that you understand what it is doing.
The biggest challenge from the Domestic Reverse Charge could be the potential hit on cashflow.
It is a big change for subcontractors who are suddenly no longer allowed to charge the VAT on invoices. While, in theory, the VAT charged on an invoice is due to be paid elsewhere, we all know that cashflow isn’t that simple. Effectively, income could be dropping by 20% on invoices, but there could still be the same number of outgoings to deal with.
For the contractor, there will seem to be a short term cashflow boost. However, and this is a very import consideration, the VAT is only being kicked down the road, and that bill is still coming.
.Gov website guidance on Domestic Reverse Charge