Domestic Reverse Charge for the Construction Industry

An overhaul of VAT in the construction industry, that was previously due to be implemented in Autumn 2019, will now come into effect on 1 March 2021.  At the time of writing, HMRC intend to press forward with this implementation date.

From 1 March 2021, many contractors in the construction industry will stop paying VAT to their subcontractors.  Instead, the contractor will pay the VAT directly to HM Revenue & Customs.  An easy way to think of the new rules is as an extension of the existing Construction Industry Subcontractors (CIS) scheme to cover VAT as well as income and corporation tax.

This “domestic reverse charge” (DRC) will have a number of consequences for businesses.  For many, the new rules are an additional complication, and it will be important to get things right to avoid problems with invoices or with HMRC.  However, HMRC say they will apply a “light touch” in the first 6 months of the new regime, and will not charge penalties for errors, so long as an honest attempt has been made to get the VAT position and filings right.

Who the DRC will apply to  

The DRC will only apply within the chain of construction contractors.  In general, if a contractor is obliged to apply the CIS provisions for payments to its subcontractors (i.e. are they approved for gross payment or is a deduction at 20% or 30% required) when paying an invoice, then the contractor will no longer pay VAT to the subcontractor.  The subcontractor will invoice the contractor without VAT, and the contractor will pay the VAT directly to HMRC by including it on its VAT return.

Most contracting businesses will continue to make some supplies which are outside the DRC, on which they must carry on charging VAT as now.  These include:

  • Supplies to “end users”, that is, anyone who will not be making an onward supply of their own construction services.  This includes the occupier of the building concerned, or a developer who will be selling the completed building.
  • Supplies to “intermediaries”, that is, persons who are linked to the end user, either by being in the same corporate group, or by both having an interest in the building worked on (e.g. landlord and tenant).
  • Supplies to domestic customers.
  • Supplies to other persons not in business, or in business but not VAT-registered.

A supplier won’t necessarily know a customer’s status as end user or intermediary, and the recent change to the DRC rules clarifies what to do about this.  The default position is that the supplier is to assume that the customer is not an end user or intermediary.  This means that, provided the customer is VAT-registered and also registered with HMRC under the CIS, the supplier should apply the DRC.  Once in receipt of written notification of the customer’s status as end user or intermediary, the supplier should charge VAT in the normal way.

If there is any doubt about whether the customer is registered for VAT or the CIS, the supplier should get written confirmation of that as well.  If the customer is either not VAT-registered or not CIS-registered, VAT will still be charged in the normal way.


Cash flow: contractors’ cash flow will be improved, and subcontractors’ cash flow will be worsened.  Subcontractors will no longer have the benefit of holding the VAT until it is due to be paid to HMRC.

Move to monthly VAT returns: some subcontractors will become VAT “repayment traders”, incurring more input VAT on materials and overheads than the output VAT they charge to customers.  As a result, they will regularly reclaim VAT from HMRC instead of having to pay HMRC.  If you will be in this position, you should consider changing to making monthly VAT returns, to get your VAT repayments more quickly and to mitigate the hit to your cash flow.

DRC supplies are excluded from the Flat Rate Scheme (FRS): This could reduce the advantage that the FRS has over the standard method of accounting for VAT.  So, if you are currently on the FRS, you should check whether it will still be advantageous, and withdraw on 28 February if appropriate.

VAT return entries: the new rules could have some unexpected effects on businesses’ VAT returns.

  • Contractors will have to put the purchase in box 7 (total purchases) and the input VAT in box 4.  They will also have to include the DRC VAT as part of their output VAT in box 1, but no corresponding figure goes in box 6 (total sales).  This could result in the output VAT total being more than 20% of the total sales, a result which until now would indicate a mistake.
  • Subcontractors will not charge VAT on DRC sales, so no output VAT goes in box 1 for them, but the sale still goes in box 6.  This is similar to the treatment of a zero-rated supply and shouldn’t cause many problems.

Assuming there are no last minute changes to the implementation date, the DRC will apply to supplies made on or after 1 March 2021.  So it will apply to all construction invoices issued on or after that date, except when the customer pays before that date.

Your invoices covered by the DRC will need to make it clear why no VAT is being charged.  HMRC suggest the following wording for subcontractors: “Reverse charge: S55A VATA 1994 applies” or “Reverse charge: customer to pay the VAT to HMRC”.  The invoice should however state the rate of VAT to be accounted for, either 5% or 20%.  For contractors self-billing, HMRC suggests the invoice narrative: “Reverse charge: we will account for and pay the VAT due to HMRC”.

A builder that uses the Cash Accounting Scheme and sells services captured by the reverse charge can still record his sales in box 6 according to the date he is paid by his customer. 

However, there is a potential cash flow gain here: if most sales are subject to the reverse charge, it makes sense for the builder to withdraw from the scheme, to accelerate input tax recovery on expenses from payment to invoice date. This is particularly worthwhile if builders take a long-time to pay their creditors or benefit from generous credit terms from suppliers.

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