Domestic Reverse Charge for building and construction services

The Domestic Reverse Charge (DRC) came into effect on 1 March 2021. It was introduced to reduce the VAT trader fraud in the construction industry by stopping output tax changing hands before it reached HMRC. Under the DRC, customers receiving building works and making onward supplies do not pay VAT to their suppliers. Instead, customers will account for the VAT themselves.

The rules are very much driven by the Construction Industry Scheme (CIS). The DRC uses CIS’s definition of ‘construction operations’, rather than the VAT definition of ’services in the course of construction’ and the DRC only applies to a service where the payment is in the scope of the CIS.

More than three years have lapsed since the introduction of the DRC on construction services and queries still arise. The guidance issued from HMRC hasn’t been overly clear, and wording has been misleading, this has resulted in confusion about the application of the DRC.

HMRC are checking correct application of the DRC when conducting VAT inspections and have carried out many CIS inspections on our clients. This article shares some of the practical issues our clients are facing with respect to the DRC and our solutions to those matters.

DRC rules recap

The DRC only applies if all of the following conditions are met.

1. The payment for the supply is one that should be entered on a construction industry scheme return, (i.e. it is a CIS ‘contract payment’). 
2. The supplier is (or should be) VAT registered. 
3. The supply is taxable at the reduced or standard rate of UK VAT.
4. The supply falls within the definition of “construction services” specified in article 5 of the Order. 
5. The supply is made to a customer who is (or should) be VAT registered, and is acting in connection with the carrying on of any business.
6. The customer is neither an ‘end user’ nor an ‘intermediary supplier’ or is but has not notified the supplier of this.

Practical issues

Practical issues with the CIS condition

The DRC will only be applicable on supplies that should be entered on a construction industry scheme return, meaning it is a CIS ‘contract payment’. The CIS covers all construction work carried out in the UK, including jobs such as: 

• site preparation 
• demolition 
• construction, alteration, repair, extension, demolition or dismantling of buildings or structures 
• construction, alteration, repair, extension or demolition of any works forming, or to form, part of the land 
• installations of systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection 
• painting or decorating the internal or external surfaces of any building or structure 
• internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration 
• services which form an integral part of, or are preparatory to, or are for rendering complete, the services described above.

For mainstream contractors, any and all construction work must be reported to HMRC via CIS monthly returns. Deductions must be applied (depending on the subcontractor CIS status), regardless of whether the DRC is applicable or not.

There has often been confusion around the CIS condition within the DRC rules – the actuality is that where the payment for the supply is not reportable on a CIS return then the DRC does not apply, and normal VAT rules should be followed.

We always recommend that a customer considers the VAT requirements initially and if all of these are met, then the CIS condition can be considered.

Practical issues with the VAT conditions

The DRC is only applicable on supplies where VAT has been charged at 5% or 20%. Any construction works which are subject to the zero-rate of VAT do not fall within the DRC – this includes the construction of dwellings.

Where contractors carry out mixed development schemes that include the construction of both dwellings and commercial builds, their supplies that relate to the commercial element may be applicable to the DRC depending on whether or not their customer has provided end user confirmation. This is the same where contactors are refurbishing a property, or perhaps changing the number of dwellings within a building.

HMRC are now incorporating questions relating to the DRC as part of their VAT inspection processes to ensure businesses are complying with the rules. Where units are being built or refurbished – and VAT has been charged in the normal way – HMRC are requesting to see evidence that confirms end user status has been provided from the customer to its supplier.

We have seen circumstances where end user status has not been confirmed to a supplier by its customer on a block of flats being developed which includes a ground floor commercial unit. This is usually on the basis that they have forgotten about the commercial element and are only focussing on the zero-rated aspect of the construction supply. When it comes to recovering the VAT incurred on standard-rated building works, HMRC may challenge VAT being recovered “in the normal way” on building works where evidence of an end user status notification cannot be supplied.

End users and intermediary suppliers should confirm their status to suppliers in order to be invoiced VAT in the normal way. The notification must be given at or before the time of supply. We expect that most contracts nowadays will include wording around the DRC and whether or not the customer is an end user. However, if you are an ‘end user’ or an ‘intermediary supplier’ , and haven’t done so already, we suggest notifying your suppliers that you meet this criteria and VAT should be charged in the normal way. This will prevent a lack of sufficient evidence being available should it come up with HMRC in the future.

In summary

As we approach the fourth year of the DRC being introduced, and are seeing increased HMRC activity on checking the correct application of the DRC – it is imperative that the basic rules are understood. Below are some of the key takeaways noted above. 

• The DRC will only be applicable on supplies that should be entered on a construction industry scheme return, meaning it is a CIS ‘contract payment’. Where the payment for the supply is not reportable on a CIS return then the DRC does not apply, and normal VAT rules should be followed. 
• Customers should consider the VAT requirements initially and if all of these are met, then the CIS condition can be considered. 
• Where there is a VATable element on building works undertaken, ensure that the reverse charge has been taken into account – if you are an end user then provide end user status to your suppliers. HMRC are now asking to see evidence of end user notifications to suppliers as part of their VAT inspections.

We understand that most construction contracts do now reference the reverse charge positions of the customer and supplier. For any long-term contracts issued prior to the DRC implementation, it is worth having these checked. For any current, or future contracts, we recommend checking these periodically to ensure the position remains the same.

If you would like to discuss how the VAT domestic reverse charge rules for construction services affect you, please contact Rob Janering, or your usual Crowe contact.