HM Revenue & Customs (HMRC) will be introducing a new set of regulations for VAT that will apply to the construction industry from 1st March 2021.
These regulations are known as the Domestic Reverse Charge (DRC).
What is the purpose of the DRC?
The DRC has been brought in to combat ‘missing trader’ fraud, where VAT registered traders that charge VAT on their sales invoices and then don’t declare or pay this VAT to HMRC.
Who and what will it affect?
The DRC will apply where:
The individual or business is registered for VAT,
Payments are subject to the Construction Industry Scheme (CIS), and
The supplies are at the standard (20%) or reduced (5%) VAT rates.
Supplies between subcontractors and contractors will be subject to the DRC unless they are connected to a contractor that is the end user (someone who uses the construction services for themselves rather than selling the services as part of their construction business).
How does it work?
Under the DRC, the customer receiving the specified service has to pay the VAT to HMRC instead of the supplier. In turn the customer can recover the VAT, subject to the normal rules for VAT recovery.
A numerical example to help clarify how the DRC works:
Currently, a supplier/subcontractor invoices a contractor £1,000 plus VAT of £200. The contractor pays them £1,200, then recovers the £200 in their VAT return.
Under the DRC rules, the supplier invoices the contractor £1,000 (no VAT is chargeable, but there is a statement on their invoice saying it is subject to the reverse charge). The contractor pays the supplier £1,000. The £200 VAT payment is all dealt with on the contractor’s VAT return, with a £200 ‘input’ and £200 ‘output’ VAT, which cancel each other out so there is essentially no VAT payment.
Essentially the ‘recipient of the works and services (where they are a contractor and not an end user) up the chain of supply will, instead of paying the VAT to the party charging it (the supplier/subcontractor), retain that VAT and pay it to HMRC (essentially discharging the VAT liability of the supplier of the works and services).
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Please note that the above is for general information only and does not constitute financial or tax advice. You should not rely on this information to make or refrain from making any decisions. You should always obtain independent professional advice in respect of your own situation.
