What is domestic reverse charge VAT?

Understanding tax regulations is crucial for running a business, especially when changes and updates are announced. 

One of these important adjustments was introduced in March 2021 and impacts the construction industry. The VAT domestic reverse charge dictates how building services providers handle VAT for certain transactions, and it’s not necessarily straightforward. 

Here we’ll dig into:

• What is domestic reverse charge VAT?
• Does the domestic reverse charge VAT affect my business?
• How will domestic reverse charge VAT change the construction industry?

The new VAT regulations are, in essence, an extension of the Construction Industry Scheme (CIS) and apply to transactions between VAT-registered construction companies, with one providing services to the other. 

In short, it means that your business won’t pay VAT on any invoice you receive from a contractor you employ directly.

Instead, you pay the same VAT payable on the transaction straight to HMRC. This rule applies to certain services contractors provide (excluding separately supplied materials) – you can find a list of eligible services that use the reverse charge here.

The contractor hired by the other building company doesn’t account for the VAT, even though they include it on the invoice, since the purchasing business handles this.

We appreciate this sounds fairly complex, so let’s look at an example of how the domestic reverse charge VAT rule would work in a real-life situation.

Our illustration is a self-employed builder who is VAT-registered. The builder employs an electrician to carry out some of the work involved in a project, and the electrician is also VAT-registered.

Before the changes, if the electrician invoiced the builder £100, they would have added 20% VAT for their work. 

The builder pays £120, claiming back the £20 VAT element as output VAT, and the electrician would pay the £20 to HMRC on their next VAT return. If you want to play around with the numbers feel free to use our vat calculator.

Now the reverse charge amends how this same transaction works. 

The electrician invoices you for £100 plus VAT, but the remittance required is net of any CIS tax deductions and VAT – so your payable value is £100. Instead, the hiring builder pays the £20 directly to HMRC, which means the VAT doesn’t need to pass from one construction business to the other before reaching the tax office. 

The reverse charge doesn’t apply to everything, so it’s best to check which services require the reverse charge and ensure that you’re using the correct VAT rate – i.e. standard rate, reduced rate or zero rate VAT.

Domestic reverse charge VAT only applies to construction businesses that are VAT registered and working with other building companies that are also registered.

Businesses are legally required to register for VAT if their turnover exceeds the £85,000 annual income threshold, but they can also voluntarily register below this threshold. 

Note that the registration threshold can change each year, so it’s important to review as your turnover grows.

VAT charges on invoices to the general public are unaffected, so you include VAT normally.

The government introduced domestic reverse charge VAT as an anti-fraud measure to tackle the estimated £120 million losses from the construction industry. 

It works by putting the responsibility on the purchasing business and avoiding firms or self-employed traders failing to declare taxes since this is paid directly to HMRC. 

There are several ways that the domestic reverse charge will affect businesses in the construction industry.

Contractors hired by other construction businesses still include VAT on their invoices but won’t receive this element since the client will pay the amount owed directly.

That means that VAT, usually at the standard 20% rate, will not reach the contractor’s bank account, resulting in a lower total cash inflow.

VAT returns aren’t always the simplest of bookkeeping tasks. The complication is that some transactions, such as those with non-VAT registered companies, separate materials purchases, or invoices raised to end customers, will still be VATable in the normal way.

The burden of responsibility lies with the purchasing business, so they must record all the VAT charges and ensure they account for these accurately before submitting each quarterly VAT return. 

Calculating the correct amount and keeping a precise record of the invoices in question is crucial when submitting your tax returns, or there could be penalties. 

If you have an accountant that supports your bookkeeping, you will need to highlight which payments and invoices are subject to reverse charge VAT. 

Construction businesses that use software to automate the administrative tasks involved with invoicing and payments must ensure that their software can deal with the reverse charge.

The risk is that you might need to repeat work manually and invest more time in preparing tax returns to ensure they are correct and compliant. 

The Countingup business current account offers a range of tools designed to make it easier for businesses and owners to manage their financial data and bookkeeping in one place.

Construction firms can view real-time trading insights, access up to date profit and loss accounts and tax estimates, creating invoices through the app that they can transmit in seconds.

As a resource to simplify the reverse charge, Countingup allows you to maintain control with fully compliant functionality to help itemise each transaction and record those sales and purchases that are reverse charge applicable. 

Download the Countingup app, and apply for a combined business current account and bookkeeping system in minutes –  you can find the app here!