There may be cash flow implications, which could be positive or negative, for the businesses concerned.
HMRC is to issue guidance on the new rules.
What is the current position?
Currently, the supplier of construction services accounts to HMRC for VAT on its supplies. The recipient of the supply therefore pays to the supplier the price plus VAT.
What is the aim of the new rules?
To prevent fraud: the new rules aim to prevent the situation where the contractor pays the sub-contractor the price plus VAT for services, but the sub-contractor then fails to account to HMRC for the VAT.
What will change from 1 October 2019?
Unless an exception applies, the recipient of supplies of construction services made to it after 1 October 2019 will be required to account to HMRC for VAT on those supplies.
Notwithstanding the fraud prevention objective of the new rules, the supplier’s motive or tax compliance record is not relevant in determining whether or not an exception applies.
What supplies of construction services will not be caught by the new rules?
The new rules should not apply where the recipient of the supply:
- Does not on-supply the construction services, so it is an end user of those services. For example, an owner-occupier or a tenant receiving services from a landlord or vice versa,
- Is a tenant (or licensee) who on-supplies the construction services to its landlord (or licensor),
- Is a landlord (or licensor) who on-supplies the construction services to its tenant (or licensee), or
- On-supplies the construction services to a connected person, and that connected person uses the services itself (that is, the connected person does not on-supply the construction services).
Contractors will need to consider carefully the position where, for the purposes of a wider land transaction, there is a construction contract, coupled with separate land sale and purchase agreements with an additional party (or additional parties) which also include construction obligations.
What potential risks and practical issues arise?
Potential anomalies where supplies of land are coupled with supplies of construction services
The boundary between what are and what are not construction supplies in the context of the draft legislation is unclear. Say a main contractor (A), agrees to construct a building for a landowner (B) and B agrees to sell the completed building to C. B will be making a supply of land (in the form of the completed building). However, as B has obligations to C relating to the construction of the building, the prospective HMRC guidance should make it clear that B is not on-supplying construction services to C and that A’s supplies are therefore not subject to the reverse charge.
There is, in any event, a potential tension with the SDLT position where a purchaser of a new development often will want to separate out the land and construction contracts into a “Prudential” type arrangement.
As a further gloss on the above example, the landowner (B) may wish to engage a development manager (DM) to oversee the development. In most cases the DM’s contract in relation to the development will be with B only, not the main contractor (A). However, sometimes the DM may be interposed in the contract chain between A and B. If so, the construction services will be supplied by A to the DM who will on-supply those services to B. In these circumstances, the services supplied by A to the DM would be subject to the reverse charge, even if the on-supply would not be caught. However, given that the DM is commercially, if not legally, acting on behalf of B, it would seem odd for the new rules to apply to the supply by A to the DM but not to the supply by DM to B (assuming B is not on-supplying construction services to C). Further still, it seems illogical for the supply by A to the DM to be caught by the reverse charge, when an identical supply by A to B (with no DM interposed) would not be caught.
Scope of landlord/tenant exception
Based on the current draft of the legislation, it is unclear whether the exceptions to the new rules include a landlord or tenant where the works are carried out outside the property demised (for example, to the common parts where those are outside the demise).
The exceptions to the new rules lack “temporal qualifiers”. For example, the exceptions refer to supplies of services (let’s say from Z) to a person A who “uses” those services to make supplies which are not construction services to B. However, the supply from A to B will normally take place after the supply from Z to A. So the draft legislation should instead say “uses or intends to use” or the like.
How is end user status to be evidenced?
Crucially, it is unclear how an end user (or someone treated as an end user within the exceptions) is supposed to evidence its end user status to the person making the supply. In the above example, even if the legislation is clarified and A is not to be treated as on-supplying construction services, how will Z know whether it needs to account for the VAT to HMRC itself? It would seem counterintuitive for A, in effect, to be asking Z to charge it VAT.
Further, quite apart from the administrative burden of evidencing end user status, many business end users are likely to be unaware of the new rules and the need to evidence end user status. Therefore, it is quite conceivable that in the case of a supply of construction services to an end user, the supplier of the construction services, on the one hand, and the end user recipient of the supply, on the other, will each think that the other party is accounting to HMRC for the VAT on the supply, so that VAT on the supply is not accounted for to HMRC. Even if the VAT on the supply does not ultimately “fall between the gaps”, the recipient may well be puzzled if, initially, it does not receive a VAT invoice.
It is perhaps ironic that end users impacted by the legislation may be unaware of the new rules and so may not be feeding in their views to the consultation.
Some sort of registration or certification system similar to the construction industry scheme may facilitate the better operation of the reverse charge.
Scope of construction services – when are materials included?
Construction services are widely defined and include repair, demolition and decoration. They will also include goods (that is, materials) included as part of a single supply of services – which begs the question as to the circumstances in which materials provided in conjunction with services are part of a supply of services, and so subject to the reverse charge, or not.
Preparatory action points
Contracts relating to supplies of construction services will need to be drafted to ensure that:
- Recipients of supplies which fall within the new regime pay only the net of VAT amount to the person making the supplies.
- It is clear from the contract whether the new rules apply.
As we approach the start date for the new regime, the parties to construction contracts should review and, where appropriate, revise their payment systems to ensure that the reverse charge rules are correctly applied.
There is no exception for supplies made pursuant to agreements entered into before 1 October 2019. This change must therefore be considered in relation to contracts currently being drafted where the construction services will be supplied on or after 1 October 2019.
The various anomalies and uncertainties to which the draft legislation gives rise (including those identified in this blog post) will hopefully be addressed by the HMRC guidance to be issued in due course. Meanwhile HMRC have requested comments on the draft legislation by 20 July and Bryan Cave Leighton Paisner (along with other major law firms) are intending to make representations to HMRC, pointing out some of the anomalies in the draft and suggesting how it might be refined so that it applies in a more logical and consistent way, with a focus on the real mischief at which the new rules are directed.
A version of this blog post first appeared on Practical Law Construction on 11 July 2018.