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VAT reverse charge for the construction industry

Morgan Montgomery Morgan Montgomery

From 1 March 2021, VAT is going to become more complicated for those involved in construction as the Domestic Reverse Charge for Construction Services (DRC) comes into effect.

Business will need to decide whether they are still required to charge VAT on their services, or whether the responsibility for VAT accounting shifts to their customer. Removing VAT from customer payments/receipts is likely to impact actual cashflows and working capital.

For the reverse charge to apply to a supply the following conditions must be met:

1 The supply is within the scope of the construction industry scheme (CIS)

2 The supply is standard or reduced rated

3 The customer is VAT registered and registered for CIS

4 The customer has not notified the supplier that they are an end user or an intermediary supplier

Please see the link to HMRC’s flowchart to see if the DRC will apply to your supply the link can be found here.

If the supply falls within the DRC the supplier will need to check the customer has a valid VAT number and confirm the customers CIS registration. Records should be kept of these details, the invoice, as well as all the normal invoicing requirements, should state that the supply is subject to the reverse charge example wording to be included from HMRC include:

  • reverse charge: VAT Act 1994 Section 55A applies
  • reverse charge: S55A VATA 94 applies
  • reverse charge: Customer to pay the VAT to HMRC.

If the customer has not given end-user/intermediary supplier confirmations then the customer should check the supplier has a valid VAT number. The customer will then need to account for the VAT under the reverse charge mechanism.

How does the change affect working capital requirements?

Depending on cash flow timings, businesses may use VAT to supplement their monthly working capital. With VAT being accounted for by the reverse charge (notional), rather than being actually paid or received, cash flows are likely to fall.

Depending where a business is in the supply chain, it could end up going from a VAT payment position to a VAT repayment position. Rather than being able to use VAT to fund working capital, additional finance may now be required to replace the VAT ‘funding’ gap.

The precise impact of these changes will be affected by the business’ debtor and creditor days, ie, the timing difference between when VAT is paid or received commercially and the date it is accounted for to HMRC.

The introduction of the reverse charge for certain supplies is going to affect different businesses in different ways, but the constant is that it is going to affect cashflows and therefore working capital requirements.

What can the construction industry do about it?

In our experience, very few businesses are correctly modelling (or even recognising) the impact of this change and therefore do not fully understand its implications. The first step is to ensure that the reverse charge is correctly applied to the business’ forecasts and therefore determine how the change in cashflow impacts the business’ ability to service its other cash outflows. Where the business is now in a regular VAT repayment position it should consider changing to monthly returns as this would reduce the cashflow impact, albeit at the expense of an increased compliance burden.

A business may determine that it needs extra working capital to fund any shortfall, or to adjust its creditor/debtor days to manage cash. How acceptable would that be to their suppliers/customers? The impact of this change needs to be considered as a whole, not just in terms of cashflows to HM Revenue and Customs.


The implications of this change are best set out in an example.

Scenario: A developer (D) has a plot of land on which they are planning to build a new office building and they have engaged a main contractor (MC) to carry out the works. The MC has sub-contracted the various areas of the build to a sub-contractor (SC1) and SC1 has in turn brought in their own sub-contractor (SC2) to carry out the work. D is the end user of the supplies, all entities are both VAT and CIS registered, and all parties can fully recover their VAT.

Pre 1 March 2021, VAT would flow through the chain, with VAT being charged on all invoices. On the basis SC1, SC2 and MC make a profit on their services, they are likely to owe VAT to HMRC each quarter when the input and output VAT are netted off.

Under the reverse charge the only cash payments of VAT are made by the MC for the materials and D for the completed contract.

Illustrative VAT cash inflows and (outflows) under both scenarios are as follows:

Without reverse charge - pre 1 March 2021
  Developer Main contractor Sub-contractor 1 Sub-contractor 2
Main contractor buys materials for £100,000 (net)   (20,000)    
Sub-contractor 2 charges sub-contractor 1 £150,000 (net) for services     (30,000) 30,000
Sub-contractor 1 charges main contractor £200,000 (net) for services   (40,000) 40,000  
Main contractor charges developer £400,000 (net) for services (80,000) 80,000    
Total cash (outflow)/inflow (80,000) 20,000 10,000 30,000
With reverse charge - post 1 March 2021
  Developer Main contractor Sub-contractor 1 Sub-contractor 2
Main contractor buys materials for £100,000 (net)   (20,000)    
Sub-contractor 2 charges sub-contractor 1 £150,000 (net) for services     0 0
Sub-contractor 1 charges main contractor £200,000 (net) for services     0  
Main contractor charges developer £400,000 (net) for services (80,000) 80,000    
Total cash (outflow)/inflow (80,000) 60,000 0 0

The above example demonstrates that the end-user, in this case D, should not be affected by the change, but the main contractor and sub-contractors are. Whether the change in cashflow is a benefit or not depends on each company’s working capital cycle. If, for example, the main contractor is paid the VAT from the developer before it is required to remit that amount to HMRC, it benefits from the VAT ‘funding’ to the extent of that timing difference. However, if MC is obliged to pay the VAT to HMRC before it is received from D, it has to fund the VAT liability (£60,000) before collecting it from D. All factors remaining equal this asset/liability position is likely to repeat itself every VAT quarter.

The sub-contractors often only supply labour, so while they charge VAT on their services, the pay little if any VAT on their costs. Under reverse charge this should end, affecting the cashflows of those sub-contractors who used the VAT to help fund their working capital. It is worth noting that the reverse charge does not apply to supplies by employment businesses, but it does to the provision of labour.

End users/Intermediary supplier

It is worth noting that the way the technical guidance is worded by HMRC gives the customer a choice as to whether they give the end-user/intermediary supplier confirmations. If the customer is an end-user or an intermediary supplier and they do not give the supplier written confirmation of this status, then the supply will fall under the DRC and VAT will not be charged by the supplier. Therefore, if you are an end-user or an intermediary supplier then some consideration should be given if you want to give this confirmation to your suppliers.

In the above example, if the developer does not notify the main contractor in writing that they are an end-user, the supply would be within the scope of the reverse charge. The developer would not have to pay VAT (£80,000) on the £400,000 charged by the main contractor which could be to the benefit of the developer (at the expense of the main contractor). Therefore, there is a cashflow advantage for the developer by not giving the end-user confirmation. The other benefit for the developer is there is a lower risk of error as it is the developer’s responsibility to ensure the end-user confirmation is correct, if incorrect confirmations are given the risk is with the developer and not the main contractor.


The DRC has come into effect and it is important to ensure all businesses in the construction industry chain understand the implications of the DRC and the various requirements for both the suppliers and customers. It is important that the DRC is applied properly, and that VAT is correctly charged this will mitigate the risk of penalties and interest being charged by HMRC for incorrect implementation of the new rules.

In times of heightened awareness of cashflows, this is a change that construction businesses, and those involved with financing them, must fully understand. Failure to do so could result in businesses running out of cash or accidentally breaching facilities. We recommend that businesses undertake a full review of the implications for them of the reverse charge in construction, enabling them to explore how to mitigate any adverse effects.

For more information, contact Morgan Montgomery or Karen Robb, VAT Partner.

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