Crackdown on construction industry VAT fraud

The government is cracking down on ‘missing trader’ VAT fraud in the construction industry with new reverse charge rules from October 2019 that will, controversially, shift the VAT liability from the seller to the buyer.

The rules are currently at the draft stage for consultation, but final legislation is expected to be issued in October 2018 to take effect from 1 October 2019.

What is a reverse charge?

A reverse charge is intended to reduce ‘missing trader’ VAT fraud, where VAT is charged by a fraudster masquerading as a genuine trader, but then absconds with the VAT.

The reverse charge is a mandatory anti-tax fraud provision and works by shifting the liability to account for VAT from the seller to the buyer.

  • In a standard transaction, the seller charges VAT, collects it from the buyer and pays it over to HM Revenue & Customs (HMRC). If the buyer is in business and making taxable supplies, the VAT is reclaimed from HMRC on the buyer’s VAT return.
  • In a reverse charge, the sale is made at the net price, so the seller does not handle the VAT and does not have the opportunity to abscond with it. Instead, the buyer calculates the VAT liability and adds the amount that would have paid to the seller to his own VAT return as if it were VAT on sales.
    • If the buyer is able to reclaim the VAT, that is done in exactly the same way as in a normal VAT charge. The two then net off and no payment is made to HMRC.
    • If the buyer cannot reclaim the VAT (being partially or wholly exempt), the output VAT that would have been paid to the seller is paid to HMRC.
    • All three parties, the seller, the buyer and HMRC, are left in the correct financial position without the seller – the potential fraudster – handling the VAT, so removing the opportunity for VAT fraud.

This is reliant on the fact that the buyer, generally being a landowner or developer, is far less likely to become a missing trader than a sub-contractor who can move on and set up under a different name with ease.

What is the effect of the reverse charge?

If the seller is conducting a missing trader fraud, then the effect of the reverse charge is to change the victim of the fraud from HMRC to the customer, the customer suffering a double tax charge, plus penalties and interest, but only if the customer fails to recognise that the reverse charge should have applied and pays the VAT incorrectly to the seller.

It is therefore vital that any businesses operating in the industry must understand when and how the reverse charge will apply to them.

The intention in the draft legislation is that every step in the chain of contractors and sub-contractors will be subject to the reverse charge except the final charge to an end customer – the retail sale at the end of the chain.

The services caught largely follow those covered by the Construction Industry Scheme (CIS). So, if a supply of labour in the construction industry would be within the CIS, whether that would be subject to a 20% deduction or a 0% deduction, VAT would be expected to be on a reverse charge.

However, unlike CIS where a single supply is a composite of supplies both within and not within CIS, for example materials, the whole single supply will be subject to the reverse charge.

What is not covered by the reverse charge?

Certain supplies are specifically excepted from the reverse charge:

  • Where the customer will use the services for a purpose other than making further supplies of specified services i.e. non-business customers such as the public, but also a business who is acting as the final customer such as a retail shop.
  • Where the supplier and recipient of the supplies are connected (within the same group), or are landlord and tenant, and the recipient will make supplies to a final customer as per the first exception above.

Who will be affected?

A sub-contractor who always works for a contractor will almost certainly not charge VAT from October 2019 but instead the reverse charge will apply to all his sales. However, a trader in the industry who works both for larger contractors and direct to the public will have to know when and when not to charge VAT and must understand the extent and circumstances of the exclusions.

If a customer is charged VAT incorrectly when the reverse charge should have applied, the customer’s obligation to account for VAT will not be removed by his incorrect payment and HMRC will have no liability to reimburse the VAT incorrectly charged.

If you would like to discuss how these charges may affect you, please contact Wendy Andrews or Robert Bailey.

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