HMRC has long been concerned that missing trader VAT fraud in the construction industry is a significant source of lost tax revenue. In this blog, we look at the important changes to how VAT will be accounted for in the construction industry from 1 October 2019 in an attempt to recover this lost revenue.
Missing trader VAT fraud in the construction sector would typically work as follows:
- A main contractor contracts with a subcontractor (say, for electrical work). Both the main contractor and subcontractor are VAT-registered
- The subcontractor incurs costs in relation to the electrical services it provides to the main contractor and is able to reclaim VAT on these via the submission of its VAT returns
- The subcontractor invoices the main contractor for the value of services provided and charges VAT on its invoices. The main contractor settles these invoices, including the VAT amount, on the assumption that the subcontractor will declare and pay it over to HMRC
- The subcontractor fails to do so and goes missing.
HMRC has paid out the input VAT incurred by the subcontractor but has not collected the output VAT.
Reverse charge mechanism from 1 October 2019
Understandably, HMRC is keen to put an end to this practice. As a result, the rules around VAT accounting in the construction industry are changing.
From 1 October 2019, services supplied between VAT registered businesses that fall within the scope of the Construction Industry Scheme (“CIS”) will be charged under the “reverse charge mechanism”. This effectively moves the responsibility for reporting a VAT transaction away from the seller to the buyer of the goods or services.
When a transaction is subject to reverse charge, the seller issues a VAT invoice stating that the supply of goods or services is subject to reverse charge. The recipient of the goods or services reports both their purchase (input VAT) and the supplier’s sale (output VAT) in their VAT return.
Both the input VAT and output VAT offset each other on the recipient’s VAT and therefore there is no impact on the recipient’s cashflow. This allows HMRC to have full visibility of the transaction and means that the subcontractor is no longer responsible for the collection and payment of its output VAT.
This effectively closes down the opportunity for missing trader fraud.
There could be a cashflow impact for subcontractors who have previously (legitimately) used VAT as a way to finance their working capital. Businesses that think they could be affected by this need to take steps now to plug any funding gaps that could arise post 1 October. We can help you with this, either by reviewing your cashflow workings and models with you or by assisting you in looking for funding.
It’s also important that contractors understand and apply the reverse charge mechanism correctly. Come 1 October 2019, it won’t be possible for main contractors to reclaim input VAT from HMRC under the old rules, even if they’ve paid the VAT to the sub-contractor. Again, we can help by looking at your invoicing systems and at the way you prepare your VAT returns.
If you would like to talk to us about how we can help you, please contact Joe Weston.