How are the rules applied for Reverse Charge VAT?
This is a continuation in our series looking at reverse charge VAT. Please read our previous article for further information.
The following example best demonstrates how the rules will be applied in practice from 1 March 2021. Both fictional parties are VAT-registered and operating under the CIS.
Tom owns a property development firm. He hires Sam to manage the conversion of an old office block into residential flats. Rich is an electrician who accepts a contract from Sam for his business to install all of the electrics in the building.
Rich (the subcontractor) is supplying a service to Sam (the contractor), who is supplying a construction service to Tom.
If Rich was to invoice Sam before 1 March 2021 for £120,000, which includes all materials, labour and works (£100,000), he would include VAT at 20% (£20,000). This would be paid over to HMRC on his next VAT return.
He would receive £120,000 in payment and have £20,000 at his disposal to support his business’s cashflow until his next VAT return liability is due. Sam would claim £20,000 input VAT on his next VAT return.
But if Rich was to invoice Sam on or after 1 March 2021, it would be for £100,000, he would state the CIS reverse charge applies and the applicable rate of VAT is 20%. Rich does not need to account for output VAT of £20,000, but neither does he have the cash available short-term to support his cashflow.
Sam would then pay Rich £100,000 and would need to account for both input and output VAT of £20,000 on the supply on his VAT return.
Under the reverse charge, Sam’s cashflow position is boosted since he no longer has to pay the £20,000 input VAT over to Rich and then subsequently reclaim it on his next return.
What do I need to do to get ready?
If your business operates in the building and construction industry, you’ll need to take the following steps to prepare if you haven’t done so already:
• check whether the reverse charge affects any of your sales and/or purchases
• update your accounting software to ensure it can deal with the reverse charge
• assess the impact of the change on your cashflow
• make sure any staff who are responsible for VAT accounting know how to deal with the reverse charge.
If you’re a contractor and you haven’t already done this, review all of your contracts with subcontractors, work out whether the reverse charge will apply, and notify your suppliers if it will.
If you’re a subcontractor who’s only learning about this now, contact your customers to find out whether the reverse charge will apply.
HMRC previously said it “understands that implementing the reverse charge may cause some difficulties”, and had promised to take a light-touch approach to any errors made in the first six months of the new legislation.
Those errors will need to be corrected as soon as possible, however, and you need to show that you were trying to comply with the rules and that you have “acted in good faith”.
Feel free to contact Marcus Bishop Associates talk you through the way the reverse charge works, and what you need to do ahead of the new implementation date. We have a complimentary financial tool for calculating VAT on petty cash for those dealing with a large number of receipts.
For further assistance
For business’s who may not have their software updated in time we may able to modify the invoice report so that your clients receive the correct form.