An overview of the Domestic Reverse Charge (DRC) here.
HMRC has published amended guidance on the DRC. The main change involves the supply of scaffolding on zero-rated new build housing. The guidance confirms the change to HMRC’s previous policy and that there will be transitional period up to 1 February 2023 where businesses can use either reverse charge accounting or normal VAT rules.
Normally, the supplier is the person who must account to the tax authorities for any VAT due on the supply. However, in certain situations, the position is reversed, and it is the customer who must account for any VAT due. Don’t get caught out!
Purchasing services from abroad
These will be obtained free of VAT from an overseas supplier. What is known as the ‘reverse charge’ (RC) procedure must be applied. Where the RC applies, the recipient of the services must act as both the supplier and the recipient of the services. On the same VAT return, the recipient must account for output tax, calculated on the full value of the supply received, and (subject to partial exemption and non-business rules) include the VAT charged as input tax.
The effect of these provisions is that the reverse charge has no net cost to the recipient if he can attribute the input tax to taxable supplies and can therefore reclaim it in full. If he cannot, the effect is to put him in the same position as if had received the supply from a UK supplier rather than from one outside the UK. Thus, creating a level playing field between purchasing from the UK and overseas.
Accounting for VAT and recovery of input tax.
Where the RC procedure applies, the recipient of the services must act as both the supplier and the recipient of the services. On the same VAT return, the recipient must
Value of supply
The value of the deemed supply is to be taken to be the consideration in money for which the services were in fact supplied or, where the consideration did not consist or not wholly consist of money, such amount in money as is equivalent to that consideration. The consideration payable to the overseas supplier for the services excludes UK VAT but includes any taxes levied abroad.
More on consideration here.
Time of supply
The time of supply of such services is the date the supplies are paid for or, if the consideration is not in money, the last day of the VAT period in which the services are performed.
Registration
If a business is not UK VAT registered, it must recognise the value of RCs in determining its turnover. That is; if its turnover is below the registration limit (currently £85,000 pa) but the value of its RCs supplies exceed this limit, it must register.
Other RCs
The RC or similar procedures can also apply in the following situations:
Import of goods (postponed accounting)
Mobile telephones
Motor cars
Land and buildings
A reminder
The twice delayed introduction of the Domestic Reverse Charge (DRC) for the construction industry will be introduced from the first of next month and affected businesses need to have the necessary procedures in place – as it won’t be deferred again.!
Details of the scheme here and here.
Please contact us if you have any queries.
Further to my article on the Domestic Reverse Charge (DRC) for builders being deferred, HMRC has announced a further delay from 1 October 2020 until 1 March 2021 due to the impact of the coronavirus on the construction sector.
Revenue and Customs Brief 7 (2020 sets out the details.
Changes
HMRC announced that there will be an amendment to the original legislation, which was laid in April 2019, to make it a requirement that for businesses to be excluded from the reverse charge because they are end users or intermediary suppliers, they must inform their sub-contractors in writing that they are end users or intermediary suppliers. Details of the DRC here and here.
As you were…
The UK Government has announced that it is to delay the introduction of the VAT Domestic Reverse Charge (DRC) for construction businesses by a year after a coalition of trade bodies and organisations highlighted its potentially damaging consequences. Details of DRC here
The DRC was due to come into force from 1st October this year, but it has been announced via Revenue and Customs Brief 10 (2019): domestic reverse charge VAT for construction services – delay in implementation that it has been deferred for a year. The new implementation date will be 1 October 2020 unless there are further delays.
The move has been welcomed by all parties affected by the rules and HMRC said that it was committed to working closely with the sector to raise awareness and provide additional guidance to make sure all businesses will be ready for the new implementation date.
Invoices etc
HMRC have also recognised that some businesses have already put changes in place to anticipate the original introduction date and appreciate that it may not be possible to reverse these changes before 1 October 2019. Where “genuine errors” have occurred, HMRC has stated that it will take into account the late change in its implementation date.
Comments
The Chief Executive of the Federation of Master Builders said “I’m pleased that the government has made this sensible and pragmatic decision to delay reverse charge VAT until a time when it will have less of a negative impact on the tens of thousands of construction companies across the UK. To plough on with the October 2019 implementation could have been disastrous given that the changes were due to be made just before the UK is expected to leave the EU, quite possibly on ‘no-deal’ terms.” The situation hasn’t been helped by the poor communication and guidance produced by HMRC. Despite the best efforts of construction trade associations to communicate the changes to their members, it’s concerning that so few employers have even heard of reverse charge VAT.”
It has been stated by certain trade bodies that more than two-thirds of construction firms had not heard of the VAT changes and of those who had, around the same number had not prepared for them. My own experience backs this up and talking to other tax people and building businesses it is clear that this is not an issue which has been publicised widely and despite accountancy firms doing their best to bring it to the attention of relevant clients and contacts, many remain unaware.
Commentary
Discussions over Brexit (obviously!) have been blamed for the situation, although there is no word about why HMRC waited until a month before the intended implication to decide to delay the DRC. A lot of work has been carried out on this matter, and changes to documentation, processing and systems have taken place which will need to be reversed before 1 October 2019. At least the delay will provide HMRC with a new chance to let affected parties know next time and gives them time to identify why so many building businesses were unaware of the reverse charge.
Whether the DRC IS introduced next year remains to be seen. To my mind, it does not deal with the major sources of tax leakage in the construction industry and, as usual, complaint business will play by the book and those that do not will find a way round the rules. To exclude labour only services appears to be a folly. Perhaps they will be amended before next year.
The new domestic reverse charge for building and construction services will be introduced on 1 October 2019. Details here
HMRC have now published comprehensive guidance which appears to cover all scenarios (but almost certainly there will be transactions which will produce disputes).
Brief Overview
The domestic reverse charge is a major change to the way VAT is collected in the building and construction industry.
It means the customer receiving the service will have to pay VAT to HMRC instead of paying the supplier.
It will only apply to individuals or businesses registered for VAT in the UK.
This will affect a business if it supplies specified services reported under the Construction Industry Scheme (CIS). A business will need to prepare for the change by:
The reverse charge does not apply if the service is zero rated or if the customer is not registered for VAT in the UK. It also does not apply to services which are supplied to end users or intermediaries connected with end users. More details here.
Please contact us if you have any queries.
Further to my article which sets out the basis of these changes, I look further at the measures which will be introduced on 1 October 2019. Time is running out for businesses in the building and construction sector to understand the impact of the new rules and to make arrangements to implement the required changes. These will include:
Background
HMRC will introduce the Reverse Charge (RC) to combat Missing Trader Fraud (MTF). The rules avoid suppliers charging and being paid VAT but failing to declare or pay this over to the government. HMRC has identified the building trade as an area where there has been considerable tax leakage in the past. The UK has introduced similar measures in response to criminal threats for mobile telephones, emissions allowances, gas, electricity and electronic communications. A domestic reverse charge only applies to supplies between UK taxable persons therefore unless the customer is registered or liable to be registered for VAT it will not apply.
The RC will make supplies of standard or reduced rated construction services between construction or building businesses subject to the domestic RC, which means that the recipient of the supply will be liable to account for VAT due, instead of the supplier. Consequently, the customer in the construction industry receiving the supply of construction services will be required to pay the VAT directly to HMRC rather than paying it to the supplier. It will be able to reclaim this VAT subject to the normal VAT rules. The RC will apply throughout the supply chain up to the point where the customer receiving the supply is no longer a business that makes supplies of construction services (a so-called end user, see below).
The supplies to which the RC will apply are set out here
Further information on the RC in general, including invoicing requirements are to be found in VAT Notice 735
Technical
As a general rule, it is the supplier of goods or services who is required to account for VAT on those supplies. However, the VAT Act 1994, section 55A requires the recipient, not the supplier, to account for and pay tax on the supply of any goods and services which are of a description specified in an order made by the Treasury for that purpose.
The final version of the draft legislation has now been published. In addition HMRC have issued guidance notes which include a helpful flowchart.
Mixed supplies
If there is a RC element in a supply, then the whole supply will be subject to the RC. This is to make it simpler for both supplier and customer and to avoid the need to apportion the supply.
End user
End users will usually be recipients who use the building or construction services for themselves, rather than sell the services on as part of their business of providing building or construction services.
VAT Returns
Suppliers
Suppliers applying the RC do not enter a figure for output tax in box 1 of the VAT Return, but should enter the value of such sales in box 6.
Customers
Customers must enter the output tax on purchases to which the RC applies in box 1 of the VAT Return, but must not enter the value of such purchases in box 6. They may reclaim the input tax on the RC purchases in box 4 of the VAT Return and include the value of the purchases in box 7, in the normal way.
Implementation
HMRC state that it understands the difficulties businesses may have in implementing the domestic RC and say it will apply a light touch in dealing with related errors that occur in the first six months after introduction.
Action
It is prudent to check whether you, or your clients’ businesses will be affected by these changes. If so, plans need to be put in place; whether as a supplier or recipient, to ensure that VAT is not charged incorrectly (supplier) and the RC is applied correctly (recipient). It is likely that output tax incorrectly shown on an invoice will be due to HMRC but will not be recoverable by the recipient and the omission of levying the RC will lead to penalties. It will also be helpful for smaller construction providers affected by the RC to examine the impact on their cashflow.
Please contact us if you have any queries or require further information.
Builders will soon be required to charge themselves VAT.
HMRC has published an important new draft Statutory Instrument (SI) for technical consultation with a draft explanatory memorandum and draft tax information and impact note. The new rules are likely to be introduced in the autumn.
This sets out more details of the intended Reverse Charge (RC) for construction services. The draft legislation will make supplies of standard or reduced rated construction services between construction or businesses subject to the domestic RC, which means that the recipient of the supply will be liable to account for VAT due, instead of the supplier.
What supplies does the intended legislation cover?
The RC will apply to, inter alia:
What is not covered?
These are some supplies which are not covered by the draft SI
Please note that neither of the lists above are exhaustive.
Further details
The rules do not apply to supplies to the end user (consumer) eg; retailers and landlords, but rather to other construction businesses which then use them to make a further supply. There are no de minimis limits, but the RC will not apply to associated businesses.
Deadline
Before these new rues come into effect, HMRC have asked for comments before 20 July 2018.
Why the new rules?
Briefly, the SI is intended to avoid Missing Trader Fraud (MTF). The rules avoids suppliers charging and being paid VAT, but failing to declare or pay this over to the government. HMRC has identified the building trade as an area where there has been considerable tax leakage in the past.
Technical
As a general rule, it is the supplier of goods or services who is required to account for VAT on those supplies. However, the VAT Act 1994, section 55A requires the recipient, not the supplier, to account for and pay tax on the supply of any goods and services which are of a description specified in an order made by the Treasury for that purpose.
Action
It is prudent to check whether you, or your clients’ businesses will be affected by the intended SI. If so, plans need to be put in place; whether as a supplier or recipient, to ensure that VAT is not charged incorrectly (supplier) and the RC is applied correctly (recipient). It is likely that output tax incorrectly shown on an invoice will be due to HMRC, but will not be recoverable by the recipient and the omission of levying the RC will lead to penalties.
Please contact us if you have any queries or require further information.
The First Tier Tribunal case of University Of Newcastle Upon Tyne is a useful reminder of the impact of the Reverse Charge.
A brief guide to the Reverse Charge is included below.
Background
As with many UK universities, Newcastle was keen to encourage applications to study from new students from overseas. This is an important form of income for the institution. It used local (overseas) agents to recruit students. Some 40% of those students were studying as undergraduates, 40% as postgraduates on one year “taught” courses and 20% as postgraduate research students studying for doctorates. In 2014 the University had agreements with more than 100 agents worldwide. The agents used their own resources to recruit students for universities around the world, including in the UK. The University entered into contractual arrangements with agents and paid commission to them. In 2008 the University paid agent commissions of £1.034m, rising to £2.214m in 2012.
The Tribunal was required to consider whether the services supplied by the agents were a single supply to University or separate supplies to both the University and students. If the entire supply is to the University then the Reverse Charge is applicable and, because the University is partly exempt, this would create a VAT cost to it. If the supplies are to both the students and the University, the Reverse Charge element would be less and the VAT cost reduced. (There were changes to the Place Of Supply legislation during the period under consideration, but I have tried to focus on the overall impact in this article.)
The University contended that agents made two supplies: a supply to the University of recruitment services and a supply to students of support services. The commission paid by the University should therefore be apportioned so as to reflect in part direct consideration paid by the University for supplies of services to it, and in part third party consideration for services supplied to the students. The supplies to students would not made in the UK and therefore were not subject to UK VAT.
Decision
After thorough consideration of all of the relevant material, the judge decided that the agents made a single supply of services to the University and make no supplies to students. This meant that the University must account for VAT on the full value of services received since 2010 under the Reverse Charge (although before 2010 different rules on place of supply applied). Additionally, it was decided the University was not entitled to recover as input tax VAT for which it is required to account by means of a Reverse Charge. There was no direct and immediate link between the commission paid to agents and any taxable output of the University or the economic activities of the University as a whole.
Commentary
It is understood that the way the University recruited students using overseas agents is common amongst most Universities in the UK, so this ruling will have a direct impact on them. It was hardly a surprising decision, but underlines the need for all businesses to consider the impact of the application of the Reverse Charge. Of course, the Reverse Charge will only create an actual VAT cost if a business is partly exempt, or involved in non-business activities. The value of the Reverse Charge also counts towards the VAT registration threshold. This means that if a fully exempt business receives Reverse Charge services from abroad, it may be required to VAT register (depending on value). Generally, this means an increased VAT cost. This situation may also affect a charity or a NFP entity.
The case also highlights the importance of contracts, documentation and website wording (should any more reminders be needed). VAT should always be borne in mind when entering into similar arrangements. It may also be possible to structure arrangements to avoid or mitigate VAT costs if carried out at an appropriate time.
We can assist with any of the above and are happy to discuss this with you.
An easy yes or no question one would think, however, this being VAT, the answer is; it depends. Typically, management charges represent a charge by a holding company to its subsidiaries of; a share of overhead costs, the provision of actual management/advisory services or office facilities or similar (the list can obviously be quite extensive).
Consideration for a supply
The starting point is; is something (goods or services) supplied in return for the payment? If the answer is no, then no VAT will be due. However, this may impact on the ability to recover input tax in the hands of the entity making the charge. It is often the case that a management charge is used as a mechanism for transferring “value” from one company to another. If it is done in an arbitrary manner with no written agreement in place, and nothing identifiable is provided, and VAT is charged, HMRC may challenge the VAT treatment and any input recovery of the company making the payment.
Composite of separate supply?
This is a complex area of the tax and is perpetually the subject of a considerable amount of case law. This has been so since the early days of VAT and there appears no signs of disputes slowing down. I have written about such cases here here here here and here
“Usually” if a combination of goods or services are supplied it is considered as a single supply and is subject to the standard rate. However, case law insists that sometimes different supplies need to be divided and a different rate of VAT applied to each separate supply. This may be the case for instance, when an exempt supply of non-opted property (eg; a designated office with an exclusive right to occupy) is provided alongside standard rated advice.
Approach
What is important is not how a management charge is calculated, but what the supply actually is (if it is one). The calculation, whether based on a simple pro-rata amount between separate subsidiaries, or via a complex mechanism set out in a written agreement has no impact on the VAT treatment. As always in VAT, the basic question is: what is actually provided?
Can the VAT treatment of a supply change when recharged?
Simply put; yes. For example, if the holding company pays insurance (VAT free) and charges it on as part of a composite supply, then VAT will be added to an original non-VAT bearing cost. It may also occur when staff are employed (no VAT on salaries paid) but the staff are supplied to a subsidiary company and VAT is added (but see below).
Staff
The provision of staff is usually a standard rated supply. However, there are two points to consider. One is joint contracts of employment which I look at below, the other is the actual definition of the provision of staff. Care must be taken when analysing what is being provided. The question here is; are staff being provided, or; is the supply the services that those staff carry out? This is relevant, say, if the services the staff carry out are exempt. There are a number of tests here, but the main issue is; which entity directs and manages the staff?
Directors
There can be different rules for directors compared to staff.
If a holding company provides a subsidiary company with a director to serve as such, the normal rules relating to supplies of staff apply and VAT applies.
However, there are different rules for common directors. An individual may act as a director of a number of companies. There may be an arrangement where a holding company pays the director’s fees and then recover appropriate proportions from subsidiaries. In such circumstances, the individual’s services are supplied by the individual to the companies of which (s)he a director. The services are supplied directly to the relevant businesses by the individual and not from one company to another. Therefore, there is no supply between the companies and so no VAT is due on the share of money recovered from each subsidiary.
Accounting adjustments
Just because no “cash” changes hands, this does not mean there is no supply. Inter-company recharges may involve the netting off of supplies so that no cash settlement is made. However, consideration is passing in both directions, so, prima facie, supplies have been made. This applies when there are accounting adjustments in both parties’ accounts.
Inter-company loans
The making of any advance or the granting of any credit is exempt via The VAT Act 1994, Schedule 9, Group 5, item 2. This exemption covers most normal types of credit, eg; loans and overdrafts.
Planning
Planning may be required if;
Specific planning
VAT grouping
If commercially acceptable, the holding company and subsidiary companies may form a VAT group. By doing so any charges made between VAT group members are disregarded and no VAT is chargeable on them.
There are pros and cons in forming a VAT group and a brief overview is provided here
A specific development in case law does mean care must be taken when considering input tax recovery in holdco, details here
Joint contracts of employment
If members of staff are employed via joint contracts or employment no VAT is applicable to any charges made between the two (or more) employers. In addition, where each of a number of associated companies employs its own staff, but one company (the paymaster) pays salaries behalf of the others who then pay their share of the costs to the paymaster the recovery of monies paid out by the paymaster is VAT free as it is treated as a disbursement.
Disbursements
Looking at disbursements is a whole article in itself, and in fact there is a helpful one here
But, briefly, if a charge qualifies as a disbursement, then the costs is passed on “in the same state” so if it is VAT free, the onward charge is also VAT free, as opposed to perhaps changing the VAT liability as set out above. It is important to understand the differences between a disbursement and a recharge as a VAT saving may be obtained.
Overseas
The above considers management charges within the UK. There are different rules for making or receiving management charges to/from overseas businesses. These charges are usually, but not always, VAT free (an example is the renal of opted office space which is land related, so is always standard rated) and it is worth checking the VAT treatment before these are made/received. VAT free services received from overseas may be liable to the reverse charge.
Same legal entity
There is no supply if management charges are made between branches of the same legal entity.
Charities
There may be more planning for charities and NFP entities via cost-sharing arrangements, but this is outside the scope of this article.
Summary
As may be seen, the answer to a simple question may be complex and the answer dependent upon the precise facts of the case. It is unusual to have two scenarios that precisely mirror each other, so each structure needs to be reviewed individually. Inter-company management charges must be recognised, especially if the recipient is partly exempt. Please contact us if you have any queries or would like more information on any of the above.