Don’t get caught out – VAT reverse charge for construction

3 April 2024 / Insight posted in Article

The VAT domestic reverse charge is more or less mandatory for commercial construction work undertaken in the UK. It requires that instead of the contractor charging 20% VAT to their customer, no VAT should be charged on the invoice and the customer has an obligation to self-account of the VAT using a reverse charge mechanism.

The most common exception to this rule is supplies of construction services made to the “end user”, i.e. where the customer is not making an onward supply of construction services, so this is typically something which applies at main contractor level, where they are either working for a developer or for a freeholder or leaseholder in an existing building. Where a contractor is providing construction services to an “end user” they are obligated to charge 20% VAT.

However, an administrative issue in who qualifies as an “end user” has started to catch some businesses out, leading to significant additional costs being incurred.

The “end user” administrative trap

In almost all cases, the contractor will know that their customer is the end user, simply from the facts of the contractual arrangement, and charge VAT at 20% to their customer, believing this to be the correct treatment and the least risky option for them. The end user will generally expect to be charged VAT and therefore recorded and recover the input VAT they are charged as normal.

However, the legislation states that to be a “qualifying end user”, and therefore for construction work to fall outside the domestic reverse charge, the customer is required to issue formal written notification of their end user status before the date on which the contractor issues any invoices with a VAT charge. If no such notification is issued, then the supply of construction services automatically falls into the reverse charge, even if the customer is an end user. The legislation contains no provision for retrospective notification.

This means that end users may end up recovering input VAT charged to them by contractors, that technically they have no right to recover. This leaves them exposed to challenge from HMRC, who can deny the input VAT recovery and/or require input VAT recovered to be repaid. We are now seeing HMRC increasingly taking this stance, causing difficulties for many end users,

Why does it matter how VAT is charged?

Commercially, there is no difference in the overall tax take between a contractor issuing an invoice with 20% VAT, the contractor paying that money over to HMRC, and the customer recovering that VAT from HMRC versus the customer accounting for VAT using the reverse charge. So, many people will no doubt wonder why HMRC are pursuing this point, when there is no overall loss of tax, and the error is little more than an administrative “glitch” in the paperwork.

While the error is essentially only administrative, there is a financial upside to HMRC pursuing this point, in the form of penalties, which can often start at 30% of the input VAT recovered, and interest, at 2.5% over base. The financial benefit to HMRC of pushing this point, and the corresponding cost to an end user, are therefore significant.

Unfortunately, these charges are calculated by reference solely to the VAT position of the end user. Even if the contractor has fully complied with their obligations and paid the matching output VAT amount in full over to HMRC, this does not reduce the quantum of either the penalties or the interest payable by the end user.

Furthermore, HMRC will not simply offset the output VAT paid over by the contractor with the input VAT recovered by the end user, meaning the contractor has to recover the output VAT paid from HMRC and the end user recover the input VAT paid from the contractor, all of which can take months, if achievable at all.

Prepare for inspections and avoid penalties

Recently, it has become routine of any inspector reviewing the VAT returns of property developers, and similar companies seeing to recover VAT on construction work, to ask for copies of the relevant end user notification. In the circumstances where that notification cannot be found, or is dated after

the first invoice from the contractor where VAT has been charged, HMRC are routinely issuing assessments against the end user.

Therefore, it is imperative contractors, and end users in particular, get their paperwork in order up front to any construction contract.

Unlike other VAT provisions which require notifications to be provided in a particular format, end user notification need only be provided in writing. So, to avoid these issues the best approach for all parties is that end user status is confirmed as part of the development or construction contract, i.e. a clear warranty from the customer confirming their status as end user, and both parties believe that any relevant construction service provided under that contract should be subject to the normal VAT accounting rules.

If you’d like to discuss VAT reverse charge, or any other tax and accounting issues, please get in touch with our real estate and construction experts.


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