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New VAT rules could cause headache for construction firms

Posted on March 01, 2021

Partner Richard Christie offers advice to construction firms following a change in VAT rules which took place on 1st March 2021, and could have a significant effect on cashflow, invoicing and reporting systems.

The delayed construction industry scheme (CIS) VAT domestic reverse charge finally came into effect on 1st March 2021, and affected businesses need to act now to ensure they are compliant.

Previously scheduled to come into force in 2019, the new rules were delayed because many businesses reported that they were not ready for the potentially complex changes and then subsequently due to the Coronavirus pandemic.

The reverse charge is a way of accounting for VAT where the supplier of construction services passes the responsibility for VAT to the primary contractor. The new rules are designed to eliminate VAT fraud in the construction industry, ensuring that the VAT responsibility is clearly identified and accepted along the supply chain. From 1st March 2021, VAT-registered subcontractors carrying out relevant work will not charge VAT on invoices to the main contractor, but instead will pass that liability to the main contractor who will account for the VAT direct to HMRC.

The new rules apply to standard and reduced-rate VAT transactions only, meaning zero rated transactions are unaffected by the new rules.

HMRC is introducing this scheme to tackle VAT fraud within the construction industry, which is estimated to cost the UK Exchequer over £100m per year. Subcontractors and main contractors will now need to consider whether the VAT domestic reverse charge applies to each contract.  If the supply is caught by the domestic reverse charge then the subcontractor will not receive the VAT element from the customer, nor be responsible for paying it across to HMRC. This could have a significant impact on the subcontractor’s cashflow.

It is important that VAT registered contractors are aware of the new rules, as businesses can face a HMRC assessment for under-declared VAT, including penalties and interest. HMRC has said that it understands that implementing the reverse charge may cause some difficulties and will apply a light touch in dealing with any errors made in the first six months of the new legislation, as long as contractors are trying to comply with the new legislation and have acted in good faith.

If they haven’t already done so, I would advise construction businesses to review the new rules and make sure they have the processes and software in place to ensure they are compliant.

In a very difficult year, this will be an additional burden on businesses, especially when VAT payments from spring 2020, which were delayed because of Coronavirus, are required by 31st March 2021. The combination of the new VAT rules and deferred payments could cause cashflow problems for large and small firms.

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