VAT reverse charge

Combatting fraud in the construction industry

The UK tax authorities have for many years struggled to combat VAT fraud in the UK construction industry. By its estimates, this costs the UK exchequer around £100m per year. In June of last year, HMRC launched a consultation to address the problem, and its findings have implications for up to 150,000 businesses involved in the construction sector.

Large construction projects often involve a chain of sub-contractors. These sub-contractors may charge and receive payment for VAT on their invoices, but then fail to pass the VAT on to the tax authorities. There are also problems with companies creating false directors or becoming insolvent halfway through an assignment. At the extreme end, criminal gangs have created shell companies to steal VAT – ‘missing trader’ fraud.

The government’s new ‘reverse charge’ seeks to stamp out these fraudulent practices and ensure VAT operates effectively on construction projects. However, it brings significant new responsibilities for developers.

The process today

To date, on property development projects, the developer owns the land and then operates with a string of sub-contractors to build and fit out the building. Each one collects VAT and passes it all the way up the chain to the lead contractor, who charges VAT to the developer.

The new rules

The aim of the new rules is to cut out the payment and recovery of VAT through the supply chain via a ‘reverse charge’, which stops having large amounts of money in the VAT system. The change in VAT rules will make sub-contractors responsible for correctly reporting VAT in their VAT returns, but as noted there is no “VAT monies” in the system. It is only the final lead contractor which will charge VAT in the normal way to the developer, who will pay the VAT and recover it subject to the normal VAT rues. The end result should therefore be neutral for fully taxable businesses, but with the advantage that no VAT monies are changing hands.

The reverse charge has been effectively used in the supply chain for a number of other areas, including laptop, mobile phone and wholesale electricity fraud. It is already in use in the construction industry in Spain and Germany.

Teething problems

As with all legislation, there are unintended consequences. We see a number of issues:

Certification - as it stands, the last person in the chain has to certify that they are the “end user” and they need to be aware of all the rules. Smaller businesses that are not regular purchasers of construction services are unlikely to know the rules and may find themselves in a position where they have not paid VAT because they failed to certify their status. In this case, HMRC have indicated they will pursue the developer rather than the contractor for any VAT due.

The new rules are due to be introduced on 1 October 2019, at a time when developers’ administrative systems need to be adapted for Making Tax Digital and Brexit, so there will be many demands for IT support over the coming year. Furthermore, the rules and guidance is still being worked on by HMRC.

What to do?

HMRC will in due course provide additional guidance on the new rules. Larger property groups are likely to have the issue in hand, but smaller or one-off developers may not be aware of the nuances.

There may be cash flow implications, either good or bad, up and down the supply chain as contractors will not have the VAT in hand for up to four months before they are required to pay it over to HMRC, but equally will not be required to pay any VAT.

It will also create more administrative problems and property developers and contractors should ensure that their technology and systems can accommodate the changes.

Penalties?

As noted above, developers will face penalties for non-compliance if they have failed to certify. The lead contractor should charge the VAT, but HMRC will target the end user, not the contractor. This could mean substantial bills for those who find themselves on the wrong side of the charge.

This is a major change for the construction industry, rightly seeking to stamp out poor practice. However, it brings a new burden on contractors and developers. Those involved need to be prepared.

If you would like to discuss the new reverse charge and how it will impact you, please contact us.

Update – 12/09/2019

It was announced on Friday 6 September that the Domestic Reverse Charge (DRC) for buildings and construction services will be delayed until 1 October 2020 (previously set for 1 October 2019).

This is due to the substantial lack of awareness of the new rules and to avoid coinciding with any Brexit. HMRC has also recognised that businesses in the construction sector will need time to prepare for the impact of new rules as well as adverse cash-flows for many affected businesses.

The purpose of the DRC for building and construction services (whereby each party in the supply chain self-accounts for the VAT until the end user) is to combat fraud. In order to avoid HMRC disallowing VAT paid, it is essential that businesses receiving building services carry out sufficient due diligence on their suppliers. This will need to be demonstrated to HMRC if there is a fraudulent party in the supply chain.

Please contact us if you wish to discuss the VAT changes further, including due diligence on suppliers and with the application and effect of the new rules when they come into force.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.