Login
In this article Ben Cussons, Business Advisory Partner, looks at some of the common mistakes businesses make when it comes to the accounting of construction related activities, and some useful guidance to ensure compliance.
What do HMRC focus on in construction?
It’s fair to say that no matter your industry, no one wants HMRC trawling through everything. It’s a costly and timely exercise and that’s without the current inefficiencies of HMRC to contend with.
However, HMRC continue to be of the opinion that the construction sector is plagued with fraud and deceit.
So, changes implemented on 1st March 2021 to the VAT regime specifically targeted the construction industry with the introduction of the domestic reverse charge scheme. Introduced to place the onus of reporting and paying to the main contractor in a construction project, and based on HMRC reasoning that many smaller sub-contractors were charging VAT when not even registered. These amounts then didn’t make their way to HMRC and were instead additional undeclared profit.
How does Domestic Reverse Charge VAT work?
In essence, although declared and shown on the invoice to the contractor, the VAT is deducted from the invoice in a similar way to the Construction Industry Scheme (CIS).
For example: If a sub-contractor invoices £10,000 for the construction services provided, with the VAT added at 20% it would make the gross value of the invoice £12,000.
Under this new regime, the VAT is the retained amount by the main contractor and the net amount due to the sub-contractor (ignoring any CIS implications) is £10,000.
The main contractor then shows an output and an input on their VAT return, for VAT due and VAT reclaimed, meaning their cash outlay is lessened by retaining the sub-contractors VAT.
This now means the sub-contractor loses out on the cash flow advantage of being paid the VAT and the timing delay in this then being paid to HMRC.
The change has seen many construction businesses, particularly those who fully sub-contract, move to monthly VAT reporting to speed up the receipt of the repayments of VAT incurred on their costs, and to aid cashflow.
But whatever side of the transaction you’re on, if you’re getting this right you’ll reduce the likelihood of an HMRC VAT review or enquiry. And whilst HMRC wouldn’t be as explicit as to say so, based on their limited resources and the objective of these reviews being to identify non-compliance, then it would make sense that if you‘re reviewed and they can see that you’re following the guidance, your chances of a future review will be reduced.
What is the Construction Industry Scheme?
The Construction Industry Scheme referred to as CIS, is applied to all sub-contractors in the construction sector when working for another contractor, be that directly for the main contractor or another sub-contractor in the supply chain of the project.
CIS is withheld from the payments made to sub-contractors and is deducted either at the main rate of 20%, the higher rate of 30% or if a sub-contractor has gross status, then 0%.
So, based on our earlier example, the amounts deducted would be either £2,000, £3,000 or £0 as the amounts calculated for deduction ignore VAT and are only on the supply of labour, not materials.
It’s worth a reminder here that gross status is only applicable to larger contractors who can demonstrate they generate enough operations to qualify and who are up to date with payment of all their other taxes. Gross status must be applied for and is not granted automatically.
There are obvious cash flow benefits to obtaining gross status as you receive in full 100% of the amounts invoiced, ignoring any retentions.
HMRC do sometimes challenge the split of labour and materials on invoices however, providing there is some sort of reasoning to substantiate the amounts charged, then they do tend to be appeased quite easily if you are compliant with your reporting.
How do I know what rate to use?
When engaging a sub-contractor, the reporting entity must verify the credentials of the sub-contractor with HMRC.
HMRC then matches this to their system to advise the rate to use.
There’s a free tool on the HMRC website to verify sub-contractors and file returns, and many of the software providers have either incorporated this into their core systems (such as Xero), or by creating more bespoke construction focused packages. It’s worth scoping out your requirements before deciding on what software package to use as you want it fit for purpose and not too much or too little.
When does CIS apply?
The short answer is pretty much all the time when it comes to any form of construction.
There is a common misconception that repair work doesn’t fall within CIS as people don’t generally view that as construction, but it does.
HMRC’s website is useful here once again, as they provide quite detailed guidance of what is and what isn’t CIS.
How do I report to HMRC and pay?
Each month you’ll need to report a CIS return and pay the amounts deducted in the same way as for PAYE. The reporting is based on when payments are made, not invoices received.
HMRC have an option for these to be filed within the entity’s HMRC online account, however an increasing number of businesses are using accounting software to capture the data as part of their day to day bookkeeping rather than it being a separate exercise.
We expect HMRC will in time make it mandatory for all businesses to report through accounting software and withdraw the use of the HMRC online account, much like they did for VAT previously.
In summary
Nobody wants to get on the wrong side of HMRC. And as they are increasingly now starting to make more noise after their slumber during covid, with more compliance checks and enquiries into both VAT and CIS, now is as important a time as ever to get it right .
We’ve got a dedicated team here at Scrutton Bland who will be pleased to assist you with your VAT or CIS reporting. To discuss any of the points raised in this article, please reach out by emailing hello@scruttonbland.co.uk or calling 0330 058 6559.
Back