The Domestic Reverse Charge: VAT Accounting for Contractors Explained

The domestic reverse charge impacts how UK contractors account for and declare their VAT obligations. First introduced in 2021, the scheme is commonly misunderstood, which may mean some contractors end up paying more VAT than necessary or make inadvertent errors in their VAT submissions.

Prompted as a measure to tackle fraud in the sector, the rules mean that a contractor purchasing a qualifying service from another VAT-registered business must account for the VAT through their next return – rather than paying the arising VAT directly to the supplier.

While reverse charges don’t count towards the mandatory VAT registration threshold, which is positive news for smaller contractors, it has caused significant confusion. Here, we’ll clarify how the domestic reverse charge works, one of the many areas the dedicated contractor accountants in our specialist team can assist with.

Understanding the Domestic Reverse Charge in UK Construction Accounting

The key change for any construction company, contractor, or other business that supplies contractors and developers is that the contractor, acting as the buyer, accounts for the VAT on the purchase.

Working alongside the Construction Industry Scheme (CIS), the reverse charge has revised the way both parties account for the VAT on their transactions. Previously:

• The supplier would include VAT as applicable on their invoice of supply and declare the amount received as output VAT on their next return.
• The contractor purchasing the service would pay the VAT directly and include the VAT paid as input VAT in the same period.

Now, the buyer is responsible for reporting the VAT on their next return, and the supplier must issue a reverse charge invoice. Part of the challenge in incorporating the reverse charge rules is that these apply in specific circumstances, meaning some sales will need to use this new VAT treatment, whereas others will not.

However, the reforms apply only to sales between two VAT-registered businesses and where the service purchased is intended for ‘resale’ to an end user, such as a homeowner. If either party is not VAT registered, or the sale is made directly to the final user, the VAT treatment reverts to the norm.

Contractor Services in the Scope of the Reverse Charge

Most services provided through the CIS will also be subject to the reverse charge rules, although zero-rated services are exempt. Examples of some of the common services provided throughout the construction industry which will usually need to have a reverse charge applied include:

• Fitting utilities and systems like power, water, and central heating connections.
• Painting and decorating or clearing properties during development and construction.
• Repairs, new constructions, and demolitions of buildings or areas of land.
• Any standard-rated construction work on temporary or permanent structures.

Generally, a service that isn’t covered by the CIS will also be excluded from the reverse charge. These might include drilling projects, professional work provided by landscapers, surveyors, and architects, and the manufacture of components used by construction firms.

Other secondary services that might potentially be provided by contractors and are not subject to a reverse charge include installing seating, security systems, and signage—provided these services are supplied independently.

However, if in any doubt, it is advisable to check with a contractor accountant with sufficient expertise to ensure you know exactly how and when to apply the reverse charge VAT rules to avoid inadvertent errors, miss-filings, or VAT over or underpayments.

Raising Reverse Charge Invoices as a Contractor

As the contractor providing the work for a client, you may need to raise a specialised reverse charge invoice when billing for your services. The administrative elements within a sales invoice remain constant and should include, as a minimum:

• An outline of the services being invoiced for.
• The details of your business and the client.
• An invoice date and number.
• A breakdown of the VAT.

Depending on the accounting software you use and whether it is compatible with the VAT reverse charge, you might be able to categorise your invoices and deal with the VAT automatically.

Otherwise, invoices should be issued with zero VAT and include an annotation indicating that the service is subject to the reverse charge. The clients’ organisation is responsible for remitting and declaring the relevant VAT to HMRC.

Most contractors accounting for the domestic reverse charge include a reference for clarity that states why the reverse charge applies – it is essential to include a note somewhere in the invoice to ensure the paperwork is compliant.

What Are the Impacts of the Domestic Reverse Charge on UK Contractors?

Our contractor accountants work with a diverse array of businesses, from extensive corporations to specialist contractors focused on highly skilled work. Regardless of your business’s size or experience, it is important to invest time in proper planning to ensure you identify and manage any impacts on your financial administration, invoicing procedures, and VAT compliance.

A common mistake is to assume that legacy software will automatically be updated to include the functionality to record reverse charge VAT values, but this is often incorrect.

The VAT must still be declared on the invoice, whether or not a reverse charge applies. Automated invoices typically account for the VAT incorrectly, which leads to erroneous VAT recoveries and repayments.

Subcontractors also need to consider how the reduced initial incomes into their businesses, without the upfront VAT revenue that would previously have been collected, may affect their cash flow planning and ongoing financial management.

Contractors reliant on slimmer margins and using the VAT element of their revenues to manage immediate payment obligations should ensure they have calculated the overall impact on their business finances and created up-to-date, accurate budgets and forecasts to avoid cash flow shortages.

Professional Assistance With VAT Accounting for Contractors

The domestic reverse charge is the latest reform to VAT and tax accounting for contractors, and making the appropriate changes is mandatory rather than optional.

Contractors are obligated to continue submitting monthly or quarterly VAT returns to HMRC and to take steps to ensure the input and output VAT declared are correct.

Should you need further information about how contractor tax laws affect your business, wish to access independent advice about the most efficient cloud-based software solutions to upscale your accounting processes, or need guidance to verify that your internal controls are sufficient, please get in touch with the James Todd & Co team at any time.

Our specialist accountancy firm is well-versed in this and other sector challenges and can offer targeted, customised accountancy services to improve your regulatory compliance and financial oversight.