In response to the escalating issue of organised fraud that has arisen within the construction sector, HMRC launched a consultation back in March to tackle what they perceive to be a major risk to the public revenue. The consultation, 'Fraud on provision of labour in construction sector: consultation on VAT and other policy options', ran for 3 months and sought the feedback from key stakeholders and individuals on policy options to prevent supply chain and VAT fraud in supplies of labour provision within the construction sector.
In light of the situation, HMRC proposed to introduce the domestic reverse charge on VAT (having seen the positive effect it has had on the energy and telecoms sectors) in the construction sector.
What is a domestic reverse charge?
The effect of a domestic reverse charge is to take VAT payment out of the transaction so the provider of the goods or services cannot disappear or fail to pay the VAT due. Instead, the purchaser of the goods or services accounts for the VAT (output tax) due to HMRC rather than the provider of the goods or services. The purchaser does this by declaring the VAT due as output tax on its VAT return. This can also be reclaimed as input tax subject to the normal rules – for most transactions the VAT is simply netted off. A domestic reverse charge only applies where both the provider and the purchaser of the transaction in question are registered for VAT.
What effect could introducing a reverse charge have on the construction sector?
Although a proven method of mitigating VAT losses, introducing a reverse charge to construction services would affect a wide range of suppliers and customers. Furthermore, the complexity of multiple VAT rates in the construction sector (a single project can include works at 0%, 5% and 20%) may cause disruption once the reverse charge has been implemented. However, since many contractors use the Self-Billed Invoice procedure, this may enable the correct rate(s) to be determined with higher accuracy.
Given the size of the construction sector, HMRC are in slight concern that implementing a reverse charge may disproportionately impact the smaller, honest businesses that aren't involved in VAT fraud. The proposed solution would be to introduce a threshold that would exclude the involvement of smaller businesses in the reverse charge scheme, based on either the value of the invoice or contract (an exact threshold has yet to be confirmed).
In short, the domestic reverse charge would eradicate tax evasion and fraudulent operations through creating a traceable accounts trail and 'fill the tax gap' in the construction sector.
When (if ever) is the domestic reverse charge being implemented?
The consultancy is still under review and the proposed strategy has yet to be confirmed by HMRC or any supporting bodies. With the on-going uncertainty of Brexit, it seems this particular strategy has been paused until Brexit negotiations have been clarified and made clear. This being said, HMRC are still active in pursuing the fraudulent gangmasters operating within the construction industry, with the latest case (whereby a construction payroll boss from Dudley was jailed for four years for a £1.3m VAT fraud) being unraveled only last week.
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