Guide to the VAT domestic reverse charge for the construction industry

What is the VAT domestic reverse charge for construction?

A VAT reverse charge is when the buyer in the supply chain is responsible for the VAT instead of the seller. This reverses the usual way of handling VAT (where the seller adds and collects the VAT).

In the construction industry, this form of VAT accounting is called the domestic reverse charge (DRC). It was introduced to combat VAT fraud.

Contractors who are VAT registered and are part of the Construction Industry Scheme (CIS) must, in most circumstances, use VAT DRC accounting practices. This means that:

• Instead of subcontractors charging VAT on services they provide to the main contractor, the main contractor takes responsibility for the VAT.
• The main contractor then calculates and submits their own CIS tax return, including any reverse charge VAT, and pays it directly to HMRC.

DRC affects most VAT-registered businesses involved in the CIS, so if you work in construction, make sure you know what your reverse charge VAT responsibilities are.

When did the VAT domestic reverse charge start?

The domestic reverse charge came into effect on 1 March 2021. Before this date, suppliers accounted for the VAT themselves.

Now, instead of charging VAT, suppliers provide a reverse charge invoice to the buyer to include in their VAT return.

Which VAT rates does the VAT reverse charge apply to?

The VAT Domestic Reverse Charge applies to construction services that are subject to both standard-rate (20%) and reduced-rate (5%) VAT. It does not apply to any zero-rated or exempt supplies.

Additionally, the value of any reverse charge services does not count towards the VAT registration threshold.

Which construction services does the VAT reverse charge apply to?

VAT domestic reverse charge applies to most services involved in construction. Even if there’s only a single reverse charge element in a supply chain, the whole supply is subject to DRC.

Services that DRC applies to include:

• Construction, alteration, repair, extension, and demolition of buildings
• Installation of systems (like heating, fire protection, and lighting)
• Cleaning or decorating of buildings during construction
• Other services that are required to complete these services

There’s a full list on the gov.uk website.

Which construction services are exempt from the reverse charge?

HMRC makes some exemptions from the VAT reverse charge within the construction industry.

Common DRC exemptions are:

• Professional services of architects and surveyors
• Drilling for oil or natural gas
• Manufacture of building components, such as machinery and utility systems

Also, if the services are supplied to the end user (such as the property owner) or directly to a main contractor who sells or lets a newly completed residential building), the DRC isn’t necessary – standard VAT rules apply instead.

What does the VAT reverse charge for construction services mean for contractors?

The VAT reverse charge could complicate your cash flow as a contractor, so you need to prepare for how this will affect your finances. As you won’t pay VAT directly to suppliers and account for it later through your VAT return, it’s important to factor this into your accounting so you have a clear view of your cash flow.

Being financially prepared through strong cash flow management, accurate invoicing, and using accounting systems that can handle domestic reverse charge transactions, will help you to navigate this challenge.

And to prevent any nasty surprises when you submit your VAT return, keep checking throughout the construction process that all supplies and purchases are correctly treated under DRC rules.

How does Making Tax Digital for VAT affect the VAT reverse charge for construction?

Although Making Tax Digital (MTD) changes how VAT records are kept and filed, it won’t change how the VAT domestic reverse charge works in your construction business. MTD means you need to digitally record all VAT reverse charge transactions so your business is MTD compliant.

MTD for trade and construction requires you to create and record invoices that show the amount of VAT subject to DRC, or the rate of VAT if the amount cannot be shown. Ask your suppliers for which the VAT reverse charge applies to give you accurate invoices that highlight that DRC is in effect.

Is there a minimum threshold from which the VAT reverse charge for construction applies?

The VAT reverse charge has no minimum or maximum thresholds. So no matter how small or large a contract is, you’ll still need to account for and prepare the DRC.

The Construction Industry Scheme and the VAT reverse charge

Domestic reverse charge is an addition to the Construction Industry Scheme (CIS), created to ensure that VAT is being properly reported by workers in the construction industry. DRC applies to all eligible transactions reported under CIS between VAT-registered contractors and subcontractors.

For this process to go smoothly, all necessary compliance checks and documentation need to be clearly reported and documented. The main contractor must check that all incoming invoices correctly identify where the VAT reverse charge applies, then account for the VAT themselves and report it in their VAT return.

Xero helps you manage your domestic reverse charge VAT

Properly accounting for the domestic reverse charge throughout the construction process is vital for compliance.

Xero’s accounting software for those in construction can help you manage your domestic reverse charge VAT – it automates DRC calculations, and you can send VAT returns directly from Xero, giving you more time to focus on your business.

Now you know the basics of DRC, delve deeper into accounting for reverse charge VAT.