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Where Taxpayers and Advisers Meet
Building Confusion in the Construction Sector: VAT Reverse Charge
09/08/2019, by Lee Sharpe, Tax Articles - Business Tax
Rating: 3/5 from 2 people

Lee Sharpe looks at the new VAT Reverse Charge in Construction regime, coming to a building site near you from 1 October 2019…

Please note important update to this article - VAT Reverse Charge for Construction Services: HMRC Announces 1-Year Delay in Implementation BUT is that Enough? 


The proposed regime was mooted as far back as 2017 and I must admit that I took a rather dim view of it then, as I do now. If anything, the light shines even less brightly than it did in 2017.

VATA 1994 s 55A allows HMRC to impose the reverse charge mechanism of VAT accounting in cases of Missing Trader Intra-Community Fraud (also referred to as ‘MTIC’ or ‘Carousel Fraud’ – albeit the latter is, strictly, a more specific setup).

At its heart, MTIC fraud relies on the VAT-free movement of goods between EC member states, such that an importer can buy goods without paying any VAT, then charge VAT on their domestic sale, and then disappear without paying over that VAT to the local tax authority – HMRC, insofar as MTIC applies in the UK.

MTIC fraud is a serious problem, estimated to cost many £billions a year in lost tax revenues, and it has vexed EC tax authorities for many years – particularly in the cross-border movement of valuable, shipping-friendly electronic items, such as mobile telephones and computer components.

Bricks, or bags of plaster, do not usually figure as high-value, ‘mobile’ items in most people’s reckoning. Nor do they tend to flit between EC member states like computer chips or mobile ‘phones. To understand why the government has targeted supposed MTIC fraud in the construction industry, you have to understand things from HMRC’s perspective, which is that:

  • HMRC is desperate to raise revenues* regardless of the cost to anyone else, and
  • It really has a thing for the construction industry – and not in a good way

In defence of at least one of those outrageous claims, I should point out that HMRC has imposed the Construction Industry Scheme – a form of quasi-PAYE – on the construction sector for decades; it has also tried to from time to time to re-categorise self-employed workers in the construction industry as employees, thereby to increase the NICs yield, often with near-comical results: if at some point in future I awaken from a Rip van Winkle-esque snooze of a century or more, I may have find that I have forgotten the name of my first pet and where I live, but I will make sure to have tattooed the findings of Castle Construction somewhere appropriate on my person, for personal amusement and posterity.

Unfortunately, the legislation at VAT 1994 s 55A basically says that the Treasury can ordain whatever goods or services it likes as being susceptible to MITC fraud (presumably even goods or services that have never crossed a border in their ill-travelled lives) and therefore subject to the reverse charge mechanism. So, onto HMRC’s merry-go-round we go.

How Does The Reverse Charge Work?

Instead of the supplier charging VAT as normal, the customer of construction services has to charge VAT to itself on those construction services it receives that are within scope. That scope is wide, although there are a couple of noteworthy exceptions.

In the c-r-a-z-y world of VAT (and specifically the reverse charge), the customer is supposed to sell the goods and services to itself: this basically creates a taxable supply and a VAT charge at the rate applicable to the supply, (which the customer of course knows and never disagrees with the supplier), and allows the customer then to reclaim the appropriate amount of Input VAT, by treating that supply as a purchase invoice, as normal. The VAT self-charged and then recovred as Input Tax will not necessarily be the same, since the customer may not itself be making wholly taxable supplies and may therefore suffer a restriction on the VAT it has just charged itself.

For many businesses subject to the reverse charge, however, the transactions are effectively self-cancelling, and the only difference for the customer is that it will end up paying the VAT that it would previously/normally have paid to the supplier, directly to HMRC instead, through its own VAT return; this really only affords HMRC a further opportunity to raise penalties for not doing things correctly. (Although I suspect I am not alone in having had the curiously unnerving experience of having to explain the reverse charge mechanism to a VAT inspector). 

It is not quite that simple: for example, the reverse charge leaves a trail through increased Outputs (more on which later) but I doubt that many trowel-wielding new members of the reverse charge club will be coloured anything other than distinctly unimpressed.

Who / What is Caught?

As noted above, the scope of the regime is wide, in that it is lifted from the definition of ‘construction operations’ at FA 2004 s 74. The legislation at FA 2004 Chapter 3 is the basis of the Construction Industry Scheme (CIS) with which many contractors and their agents will be painfully familiar. CIS has the dubious accolade of being probably the first commonplace regime where HMRC’s greed for penalties became publicly shameful, and had ultimately to be watered down.  (Hardly the last, though: see for example HMRC’s Penalty Regime Laid Bare and consider what will happen when that regime – and worse – is onshored from April 2020).

The detail of the kinds of services within the scope of FA 2004 s 74 is long and not worth reproducing here but suffice it to say that, if you are likely to get your hands dirty on a building site, then you are likely to be caught. In case you are struggling to find a copy of FA 2004, the government has basically reproduced the relevant parts in The Value Added Tax (Section 55A) (Specified Services and Excepted Supplies) Order 2019. The CIS340 Booklet on how CIS operates and what it applies to used to be an excellent resource but, as with all formerly-excellent HMRC resources it is no longer available as a downloadable .pdf (God forbid, as an actual booklet) just in case you actually download it, actually rely on it, and then find that HMRC has - yet again - surreptitiously amended its guidance without telling anyone.

There is, notwithstanding, some efficiency to be found in the harmonising of the regimes: if it is within the scope of the CIS regime, then it will be caught for the new VAT reverse charge on construction …except when it is not. One of the most important distinctions is that traditional CIS applies only to services and not to materials, whereas the new reverse charge VAT regime treats any ‘mixed’ supplies containing in-scope elements, as a single supply, wholly subject to the reverse charge mechanism (see Article 9 of the aforementioned Order).

Useful Exclusions

Key exceptions to the rule that being caught for CIS means being caught for the Reverse Charge are:

  • The reverse charge does not apply if the service is zero-rated for VAT or if the customer is not registered for VAT in the UK
  • “End users” – not necessarily just the customer at the end of the supply chain, but anyone who receives such services but uses them for any purpose other than making further supplies of construction services subject to the reverse charge - see “interpretations” at Article 2 in the aforementioned Order; this is expanded to cover “intermediary suppliers” who are (basically) connected with such End Users
  • The usual services or operations specifically excluded from scope for CIS purposes – as replicated in the Order
  • Any supplies in respect of which a payment is not required to be included in a CIS return under Reg 4 of The Income Tax (Construction Industry Scheme) Regulations 2005 (SI 2005/2045) – but noting that even if a supply is only partly ‘caught’ for payment under the CIS regulations, then it will be treated as being wholly caught for the purposes of the reverse charge mechanism (and that gross payments made under ‘construction contracts’ in the CIS are still ‘returnable’ under those regulations, so one cannot avoid the reverse charge simply by hiring only sub-contractors with gross payment status under the CIS regime). Legislatively speaking, this makes for a reasonably steady anchor to the original CIS regime specification.

Note also that whether or not a particular activity or service is within the scope of CIS is not always cut and dried: I recall HMRC’s grudging acceptance that installations of a certain kind were not within scope, when contesting a client’s potential drowning under CIS penalties – literally over a hundred received in one day alone, and I suspect their postman still has flashbacks. More seriously, I understood from the group’s chairman that if HMRC’s penalties had been upheld, rather than being reduced to nil, then the entire group would have been at risk: the CIS penalty regime was truly and unapologetically Draconian, and has scarcely improved since.

Things You Maybe Didn’t Even Realise You Should Be Grateful For

One of the key savings that will understandably have been overlooked by most people is that, as mentioned above, the reverse charge mechanism ADDS the reverse charge supplies received to the customer’s own supplies or Outputs, as a kind of ‘self-billing’ process. This would ordinarily ‘count’ for determining if a business is making sufficient taxable supplies that it needs to be registered for VAT. In other words, this would have been an ingeniously crafty means to nudge many hitherto unregistered micro-businesses in the construction sector into the VAT regime (and, of course, that other bane of taxpayers’ existence that is Making Tax Digital).

I suspect that HMRC feared that the bad publicity from such a manoeuvre might be so great as to undermine their assault on taxpayers more generally, so wisely included Article 10 of the above prospective Order to ensure that this would not happen – such Outputs will not count towards the registration threshold – insofar as the MTIC reverse charge applies to the construction industry, after adding VATA 1994 s 55A (9A) to give itself the power to make that inclusion. Well, we wouldn’t want anything getting in the way of Making Tax Digital, joint and several personal liability for tax debts or the loan charge fiasco, would we?


Businesses already caught by the Construction Industry Scheme will often be subject to the new VAT Reverse Charge mechanism. The person who supplies the service for VAT purposes is responsible for determining if the reverse charge is in point, and whether or not VAT should be included in the invoice raised. The customer is in turn responsible for applying the reverse charge in its own account to HMRC as well.

This will be a cashflow and administrative nightmare for businesses in the construction industry, and the burdens will fall heaviest on the smallest businesses.

Let’s suppose that a self-employed electrician does a job worth £1,000+VAT for a contractor. The VAT on the invoice would ordinarily be £200, but that will no longer be charged on the invoice, which will instead, say “reverse charge: VAT Act 1994 Section 55A applies”, or something similar.

He or she will also suffer a 20% withholding under CIS, assuming the business is registered but not for gross payment; he or she will also no longer receive the VAT that would ordinarily be charged on that invoice, and will therefore will have personally to fund any Input VAT costs incurred to date.

As they are no longer receiving any Output VAT, such traders will often be in a VAT repayment position, which will in turn mean that they will probably have to go onto a monthly VAT return schedule to minimise the damage to their cashflows – which are already restricted thanks to the operation of CIS retentions. And this is in fact the whole point of the reverse charge mechanism: the smaller/riskier entities at the beginning of the construction chain never get to see the VAT charged on the supplies they have made, so they cannot disappear without having paid it over; it's just that the vast majority of legal businesses in the affected sector then have to bear this burden instead, leaving HMRC sitting pretty on a pile of cash that those legal traders then have to ask for, to cover their own VAT costs. Readers should be in no doubt that HMRC absolutely plays the cashflow game, and plays to win - whatever the cost (3 separate links, to 3 new, separate measures - there are more).

There will also need to be extensive communication between the sub-contractor and the contractor – including verifying that the contractor is subject to CIS and VAT-registered, or is an end-user or intermediary. Because, in the VATman’s eyes, you need permission and evidence not to charge the 20% VAT you would dearly like to have used to offset your own VAT costs.

Reverse charge supplies are incompatible with the Flat Rate Scheme, and with Cash Accounting. Many smaller businesses will have to look at the types of work that they do, to see if there is any point in staying in either scheme (strictly, one cannot be in both although there is a Cash Accounting version of the Flat Rate Scheme).

Getting this right, so as to avoid any penalties, will be a huge headache for smaller businesses. Software will almost certainly become more expensive as compliance with the reverse charge process will be at a premium.

The largest contractors will probably benefit from a cashflow perspective, because they will no longer have to pay Output VAT on invoices received (that are subject to the reverse charge); instead, it will effectively increase the amount of VAT for which they will have to account to HMRC when they make their next VAT return. Those largest contractors will have to devise systems to comply with the reverse charge mechanism, including managing relevant communications with their sub-contractors.

Contractors in the middle of the construction chain will have to set up systems to apply the reverse charge in relation to in-scope payments made to sub-contractors as well, but are likely still to suffer from cashflow difficulties because they will in turn be unable to charge VAT on their (presumably) larger invoices upstream to their own contractor(s).  They will also suffer from the increased administrative burden as smaller sub-contractors, both when dealing with queries from their sub-contractors and when dealing with their upstream customers, as sub-contractors in their own right. This is on top of the extra work they already have to do for HMRC, such as managing monthly CIS returns.

VAT in construction was already complex, and this will only make matters worse. HMRC has said that it will operate a ‘light touch approach’ to penalties for the first 6 months of the new regime; after that, construction businesses look set to be even more lucrative penalty factories for HMRC than they were before. Anyone who has dealt with CIS for long enough will recall ‘halcyon days’ for HMRC when CIS penalties could often reach the best part of £100,000, regardless of whether or not any CIS tax was actually due.

People who will not be caught, as a rule, include:

  • Property Developers, because they will count as “end users” – they will not in turn be supplying construction services, but houses, flats, etc. (This could change if the developer sells a part-complete property with an agreement to develop to completion but with new-build dwellings, zero-rating could in some cases step in to prevent the reverse charge.)
  • Property Investors – again, they will usually count as End Users
  • Tenants in business on their own account or otherwise (ditto/and because they may not be VAT-registered in the first place)
  • Employment businesses supplying construction workers (because their supply is usually that of staff, not construction services, so End User)
  • Utility companies – End Users by a similar rationale
  • Local authorities and other public bodes - likewise

It follows that sub-contractors to all such clients will generally be able to avoid the reverse charge and be able to charge VAT on their invoices, so as continue to subsidise their own VAT costs.

As an aside, come readers may be surprised to find that Property Investors are caught by CIS in the first place, given that their business would not normally be considered to include ‘construction operations’ but they should read CISR12080 and note that Mundial Invest SA v Moore (HM Inspector of Taxes) [2006] does support HMRC’s position that property investors can be caught under the CIS regulations when taking on a substantive development project (although Thornton Heath LLP v HMRC (2018) will potentially help some property investors). I must admit that I was disappointed that HMRC did not take the opportunity to remove property investors from the scope of CIS (please note that the linked article is more than 4 years old and the Manual has since been updated) but… you know, HMRC has got to get those penalties somehow.

So, Why?

The government has said that it needs to instigate this regime in order to combat “missing trader” fraud (but not “missing trader intra-community fraud”). On the face of it, that would seem entirely reasonable. But is it?

The Federation of Master Builders (FMB) recently wrote to the new Financial Secretary to the Treasury, to request a 6-month delay to the implementation of the new regime, writing that “construction SMEs and sole traders, which make up 99% of the one million construction firms operating in the UK, will have do this themselves, on top [of] running the day-to-day activities of their businesses”.

It is interesting that the FMB suggests that as many as a million businesses will be affected, because HMRC previously said that ‘only’ around 100,000 to 150,000 businesses would be affected. It is difficult to understand how HMRC can have missed the other 850,000+ businesses. (Actually, it’s not: HMRC has a long and chequered history of “back of fag-packet” calculations when it comes to its estimates for Tax Impact and Information Notices – which is why I am leaning towards the FMB’s figure having more credibility)

But actually, whether it be 100,000 or indeed 1,000,000, is it right to subject so many businesses to this new regime – where even HMRC admits the impact on business administrative burdens “is expected to be significant” – to prevent missing trader fraud in the construction industry? How much is missing trader fraud in the construction sector actually costing the Exchequer?

£80 million a year, according to HMRC's latest estimates: that’s how much it expects to recover, annually, once the regime has settled in. That’s a lot of money, no question, equating to roughly one ten-thousandth of the total revenue collected by HMRC in 2017/18. But weighed up against 150,000 businesses, as per HMRC’s original estimate, it’s about £500 per business. Given the cashflow damage and administrative time-suck involved, I reckon it will actually cost real businesses more money in real terms, to save HMRC £500 each, per year (if the FMB’s higher figure of a million businesses is correct, then that equates to a frankly pitiable yield of £80 a year, per business). Smaller businesses risk being hit hardest cashflow-wise, relatively speaking, and will have the least access to support and expertise when it comes to accommodating all the administrative aspects – which HMRC, again, admits will be significant.

But, to be clear, if the FMB is correct, and this will actually affect up to 1 million businesses, then the cost and disturbance to roughly one in every 6 or7 businesses in the UK base, dwarfs the annual monetary saving that HMRC hopes to make.

The funny thing is, HMRC should have a really good grasp of which businesses will be affected because it, after all, processes CIS returns every month and we have already established that there is (deliberately) a very strong correlation between CIS and the new reverse charge. Given that the publicly-accessible Parliamentary Briefing Paper on UK Business Statistics published in December 2018 said that there were 992,000 businesses in the construction industry last year, representing 1 out of every 6 businesses in the UK, it seems that the FMB’s homework is more on the money. Or perhaps there are at least 5 end-users for every construction chain in the UK? A ridiculous proposition.

Of course the starting figure of 1,000,000 businesses will be whittled down by cutting out End Users and those entities that are not VAT-registered, etc., etc. But it will then be swollen by those deemed to be caught by CIS/the reverse charge but would not otherwise consider themselves to be ‘construction businesses’. And the Office for National Statistics puts the total number of businesses in the construction sector alone that were registered in 2018 for VAT, PAYE or both, at 332,000 – more than double the top end of HMRC’s estimate. There may be a good proportion of construction businesses that are registered for PAYE but not for VAT; there will also be a good number of construction businesses that are not VAT registered but will nevertheless be adversely affected by the new regime (as cashflow trickles down – or, more accurately, does not)


The additional burden on construction businesses in introducing this regime will not just be “significant”: it will be huge, whether it affects a million businesses or 'only' a few hundred thousand. And it will be ongoing. The Federation of Master Builders has highlighted how little HMRC has done to warn the (all but indisputably) hundreds of thousands of businesses that will be affected by these substantive changes – perhaps HMRC has an eye to how quickly the 6-month ‘light touch penalty period’ will evaporate. True to form, HMRC seeks to rely on a couple of announcements and the odd Twitter update and, I expect that when a few of the many penalties for non-compliance that will doubtless follow are challenged it will, as usual, argue that “ignorance of the law is no excuse”.

But even if HMRC gave such businesses all the time in the world, the inarguable and inexcusable fact is that HMRC is – yet again – imposing increasing burdens on a great many businesses, which the supposed benefit to the UK taxpayer simply cannot justify. There are precious few quids for all this quo.

About The Author

Lee is TaxationWeb's Articles & News Editor and writes for TaxationWeb. He is a Chartered Tax Adviser with experience of advising individuals and owner-managed businesses over a broad spectrum of tax matters.
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