One of the most recent announcements from HMRC has been a consultation about SIGNIFICANT changes to the CIS and VAT rules for contractors. The primary aim is to reduce income tax, PAYE and VAT avoidance in the construction industry. And one of them includes the introduction of a reverse charge VAT procedure; requiring customers to pay VAT on construction services INSTEAD of the contractors.
The new proposals would put the legal responsibility for assessing and paying the right amount of tax onto the customer, rather than the contractor.
The consultation paper is available on the HMRC website: http://tinyurl.com/knsbvxu. Pages 7 – 12 deal with the VAT issues. It is a detailed document and chances are that unless you’re an accountant or tax expert or work in the construction industry, you’ll find it a difficult read. It contains proposals to change the CIS scheme and to introduce a VAT reverse charge for construction services provided to businesses. The big accountancy firms and the accountancy/tax press have written about it, but I suspect that there are a LOT of SME business owners who have no idea of how the proposed change can affect them.
Either way, if you’re involved in buying or selling construction services, I’d strongly recommend that you read the consultation paper. We have until the beginning of June to respond to the proposals.
The consultation paper suggests that a threshold for the scheme could be £250,000 annual threshold or monthly threshold, although it’s not clear whether this would be on an invoice or contract basis. The other main areas of uncertainty include whether the main contractor or final VAT registered business customer would have to account for VAT and even whether others involved in construction, such as architects,engineers could be included in the scheme. The type of work involved could be defined under the CIS definition, though it could be different for VAT.
Reverse charge for business to business transactions: customers to pay VAT
Let’s just take a step back and think about all of this. Anybody in property and construction industry knows that the VAT rules are complicated. Contractors have to decide whether to charge 20% for their work, or take the risk and charge 5% or 0% and hope that HMRC agree with their assessment. If you’re the customer, you’ll want to make sure that the contractor doesn’t charge too much VAT, but it is the contractor’s responsibility to decide the VAT rate and collect the VAT from the customer.
Here’s a simple example showing how it would work in practice:
- Current rules: Suppose a contractor does £100,000 worth of work that is liable to 20% VAT, the contractor will issue a VAT invoice for £100,000 plus VAT of £20,000 and pay the £20,000 to HMRC.
- Proposed rules: The contractor changes £100,000 net of VAT and the customer pays the £20,000 to HMRC by including it on their VAT return. The customer can claim the VAT as input tax on his VAT return under the normal rules. That means if his business is mostly VAT exempt, e.g. residential lets, then the customer can’t claim the VAT or can only claim a proportion. However if the work relates to taxable business, e.g. holiday accommodation, then the VAT can be claimed.
If you’re a property developer planning to buy and covert commercial to residential, it could mean that you’d have to deal with the VAT liability of the contractor’s work and pay the VAT to HMRC. For now, it’s the contractors liability – now, as owners, developers, landlords, the onus would fall on YOU to establish the correct VAT and pay it to HMRC. If you’re not currently registered for VAT, then you may have to register to pay the reverse charge VAT under the new rules. Either way, you’d be liable for any errors if you get it wrong.
Any business employing contractors over the threshold limit would have to pay the VAT on the contractors’ services.
You might assume that it won’t matter too much because you can claim the reverse charge VAT as input tax on your VAT return. You’ll play it safe and pay 20% VAT on everything.
But what if you pay £20,000 and claim £20,000 but HMRC then decide that the work qualified for the reduced 5% rate, so the correct amount of VAT was £5,000, not £20,000? In principle, HMRC can issue an assessment for “overclaimed” VAT for the £15,000 difference. You may have to go through a separate process under the “adjustment of error” procedure to claim back the overpaid reverse charge VAT of £15,000.
There are so many potential issues that could arise in respect of this proposal. For example, if there’s a threshold for smaller businesses/contracts, we all know that there are ways round such rules if the contractor and/or the customer is determined to avoid paying VAT. And it could be complicated even if the contractor/customers are trying to get it right.
For example, suppose you’re a property owner and in one year, you plan to spend £240,000 on conversions or renovations but halfway though it’s clear that the cost is going to be closer to £300,000. Would the liability pass from the contractor to the owner at some point during the contract?
HMRC have also asked for comments about the proposed implementation date and transition period for any such new rules. At this stage, I really don’t think that they have any real idea about the potential practical problems with this proposal so I hope that there is a long lead in time to enable people to prepare.
Just as a final thought on this: it is up to businesses to respond to this proposal. VAT consultants and accountant can say a lot of things to HMRC, but it is up to YOU as businesses to put the pressure on and contact your trade organisations and your local MPs to get clarity on these proposals and ensure that HMRC appreciate the problems it could cause in practice.
HMRC will almost certainly introduce the changes in some form or another. This is your opportunity to have your say about how it could work.
I know that some people won’t want to respond to HMRC directly, but if you want to make any comments you can make them below or email me firstname.lastname@example.org and will summarize the main issues in my own response to HMRC.