VAT Domestic Reverse Charge

Listed Under: Blogs

The new VAT Domestic Reverse Charge (DRC) for construction services comes into force on 1 October 2020.  This will necessitate changes in accounting systems and practices and is likely to have a negative impact on the cashflow of subcontractors.


Why is this change being made?

HMRC are seeking to combat what is known as “missing trader fraud” - with estimates suggesting that this amounts to over £1bn of VAT not being collected by the government each year.   The DRC tackles particular issues in the construction sector in a similar manner to measures taken with intra EU trade and transactions in the mobile phone and computer chip sectors.


Who does this apply to?

It is estimated that 150,000 businesses will be affected by the DRC. 

The DRC will apply to transactions for specified services between VAT registered businesses – whether sole traders, partnerships or limited companies – where the recipient then makes an onward supply of those services.  Specified services are in essence those activities that are covered by the Construction Industry Scheme, another anti-fraud measure applying to the construction sector.

It will not apply where the customer is the end user of the service (for example, a business that has construction work undertaken on a building that it uses for its own activities) or where one party to the transaction is not VAT registered.  Similarly, it will not affect construction businesses that trade with consumers.


What activities are included in Specified Services?

Examples of activities falling within the scope of the DRC include:

  • Groundworks or other preparatory works
  • Construction or alteration and repair of buildings
  • Installation of heating, lighting and power systems
  • Internal and external painting and decorating

The DRC will not apply to the services of professional architects and surveyors or for the repair of heating, lighting and power systems


So what will change?

A VAT-registered business, which supplies qualifying construction services to another VAT-registered business for onward sale, will be required to issue a VAT invoice stating that the service is subject to the DRC.  They must:

  • Not add the VAT amount to the invoice.  Just invoice the net amount.
  • Clearly state that the reverse charge applies and the applicable VAT rate
  • Ensure that their customer knows that they must account for VAT to HMRC


The customer then must account for the VAT due on that supply through its VAT return, instead of paying the VAT amount to the supplier. To do this there is an additional entry of the output tax in box 1 of the return.  Accounting software will of course manage this based on the choice of the correct VAT code.   The customer may recover the VAT amount as input tax, subject to the normal rules.


Impact on Construction Businesses

Many businesses rely on the positive cashflow benefit from collecting VAT and then holding this for a period of months to use as working capital until it is paid to HMRC.  They will no longer have this source of funding available and the sudden, though well trailed, change in October 2020 may cause a significant issue.

Some businesses may find that they become a net reclaimer of VAT when they are no longer charging VAT on their sales as they are covered by the DRC.  Where this happens it may be worth considering moving to the monthly submission of VAT returns to obtain the refund more quickly thus helping cashflow.  Of course this will increase the administration of VAT.  However, those using modern cloud accounting software will be able to submit VAT returns easily and quickly so this should not be a major issue.

For contractors it may be cashflow beneficial if the subcontractors supplied other goods and services along with the DRC activities as these would all fall within the remit of DRC.  Thus the contractor would not then have to fund the cashflow of the VAT on these other goods and services.  This would especially apply where a subcontractor submitted monthly VAT returns and could recover the input VAT quickly.


Actions Required

Accounting systems will need to be updated to ensure that transactions can be processed according to the new rules with a clear cut off based on tax point dates on or after 1 October 2020.   Businesses that use one of the major cloud accounting software systems can relax as they will have these changes installed automatically.  Those with older installed and server based systems will need to contact their providers to ensure that the required changes are made on time.

Businesses will also need to determine the exact status of their customer – are they a VAT registered business, are they covered by the CIS, and are they an end user or not.  This may not always be obvious.  The confirmation of this will need to be documented and retained as evidence to support the invoicing decisions made.  It is recommended that this process is completed well ahead of the implementation date of 1 October 2020 and that this evidence is collected as matter of course in contract discussions in future.



If you would like to learn more about this matter, or indeed any other business accounting or taxation issue, and how it will affect your business please do get in touch.  We offer a free no obligation initial discussion and will seek to understand your issue in detail to enable us to offer practical insight and tailored advice.   

E mail:     Telephone:  01905 928128