Changes to the application of VAT to certain supplies of construction services came into effect on 1 March 2021, requiring the operation of the reverse charge on affected supplies. Businesses in the construction sector, as well as businesses, including landlords and occupiers, which contract with businesses in the construction sector, should consider the implications of this change to their business and ensure that they comply with the new rules.
In particular, the application of the reverse charge is to a degree voluntary in so-called "end user" and "intermediary supplier" scenarios and businesses in this position, such as landlords and tenants, should carefully consider whether they wish the reverse charge to apply or not.
Background
Legislation to introduce a reverse charge on certain supplies of construction services was enacted in the Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) Order 2019 (SI 2019/892). This, in general terms, introduces a VAT reverse charge on supplies of construction services to which the provisions of the Construction Industry Scheme (CIS) also apply. However, since the purpose of the legislation is to prevent missing trader fraud opportunities within the construction industry, the legislation includes a number of exceptions for low risk situations, such as where the supply is made to the end user or certain "intermediary suppliers".
The introduction of the rules was delayed twice - first, to allow more time for businesses to prepare and second, due to the coronavirus pandemic. However, the rules have now been brought into effect from 1 March 2021, albeit with some modifications to the original version of the rules.
Operation of the reverse charge
Under the reverse charge measure, the VAT on certain supplies of construction services ('specified services') will need to be accounted for to HMRC by the customer rather than the supplier. The intention of the legislation is that, in general, the reverse charge will apply to construction services which are also required to be reported through CIS .The reverse charge will generally apply throughout the supply chain up to the point where the customer receiving the supply is no longer a business that makes onward supplies of specified services. The reverse charge will also apply to goods where those goods are supplied with the construction services.
It should be noted that the rules will apply not only to supplies by construction businesses, but also where a the recipient is a "deemed contractor" under the CIS rules. This will potentially include many landlords and tenants which carry out substantial amounts of refurbishment or fit-out works as they will be deemed contractors if, broadly, they have spent £3m or more on building work in any three-year period. (With effect from 6 April 2021, deemed contractors will only have to register if their expenditure on building work exceeds £3m in the previous 12 months, rather than over three years.)
Construction services
The rules define "construction services" as covering a wide range of services including construction, alteration, repair, extension, demolition of buildings, structures or works forming part of land , installation of systems of heating, lighting, air-conditioning, power, drainage etc, internal cleaning when carried out in the course of other construction works, painting or decorating and other services integral or preparatory to such services. The definition is based on the definition of "construction operations" used in the CIS.
The legislation also includes a list of excluded services such as the professional work of architects, manufacturing building components and installation of security systems (unless they form a single supply with other construction services).
In relation to landlord and tenant scenarios, it may not always be clear whether payments are for "construction services" or simply made as, for example, an inducement to the tenant to enter into a lease. A careful analysis will be needed on a case by case basis to ensure that the rules are applied correctly.
In addition, landlord and tenant scenarios can involve supplies of construction services in either direction. For example, a tenant may undertake landlord's works for the landlord (a supply of construction services by the tenant to the landlord) or a landlord may carry out tenant's works or make changes to its base build which are paid for by the tenant (a supply of construction services by the landlord to the tenant).
Excluded supplies
Article 8 of the Order lists certain 'excepted supplies'. These include:
supplies where a payment is not required to be included in a return made under the CIS;
supplies of specified services to an end user; and
supplies to an intermediary where either (i) the intermediary is connected with the expected end user of those services or (ii) the supplies are made in relation to land, buildings or civil engineering works in which both the intermediary supplier and the expected end user of those services have a relevant interest (such as landlords and tenants).
End users will generally include any business that utilises the construction services for their own purposes, rather than for making an on-supply of construction services. This would include occupiers of the premises worked on, landlords and tenants of the property worked on and developers of property.
Intermediary suppliers would include a landlord receiving construction services from a building contractor for the purposes of undertaking construction works for a tenant, a tenant receiving construction services from a building contractor for the purposes of undertaking construction works for a landlord or a group entity through which construction services are procured for other group companies.
In relation to the exceptions at (b) and (c) above, the legislation now provides that a supply will not be treated as an excepted supply unless the recipient confirms to the supplier in writing, no later than the time of the supply, that the conditions for the exception are satisfied or alternatively, given this confirmation in the agreement under which the relevant supply is made. If the recipient of the supply does not notify the supplier, then a supply to an end user or intermediary will fall within the reverse charge. In fact, this may have cashflow benefits for the recipient of the supply as, rather than paying VAT to the supplier and then later recovering it in their VAT return, no VAT is paid and (assuming that it can be recovered) it is simply an accounting entry in the recipient's VAT accounts.
It will be important in such cases for the recipient of the supplies to carefully consider whether in fact they wish to provide the necessary notice in writing or not.
Comments
The introduction of the reverse charge is potentially significant for those supplying construction services and also those receiving construction services, such as developers, landlords and tenants. Indeed, it is estimated that up to 150,000 businesses could be required to operate it on supplies they make or receive.
Whilst only businesses that receive supplies where payments are reported through the CIS will have to apply the reverse charge, this will also include many non-construction businesses such as larger landlords and tenants because of the high value of their purchases of construction services. Whilst these businesses may nevertheless come within the "end user" or "intermediary supplier" exceptions so that it will not be necessary to apply the new reverse charge provisions, it will be important that they recognise the potential application of the rules and decide whether or not they wish to make the necessary notification to disapply the reverse charge.
The risks of failing to identify where the reverse charge applies are particularly troublesome for the recipient. Should the supplier charge VAT to the recipient when the reverse charge should have been applied, the recipient should not be paying the VAT to the supplier since that is not VAT which was properly due. Should the recipient nevertheless seek to recover that VAT from HMRC, that will be VAT which the recipient has over-recovered, leaving them liable to repay HMRC, with interest and potentially penalties - and having to seek repayment from the supplier for the VAT overpaid.
Importantly, this measure will apply to supplies of construction services under existing contracts which are treated for VAT purposes as made on or after 1 March 2021 - this could include where the only payment outstanding at 1 March 2021 is a retention payment. Accordingly, businesses should also consider the impact of the introduction of the reverse charge on their existing contractual obligations.
Businesses potentially affected by the reverse charge will need to be live to whether the application of the reverse charge could change during the life of a contract - for example, where a person which has previously notified "end user" status ceases to be an end user or a person which was not originally a CIS contractor becomes CIS registered. A recipient of construction services that fails to identify that change and alert the supplier of the change of treatment is especially at risk of VAT accounting errors.
