From 1 October 2020 HMRC will introduce a VAT domestic reverse charge (Reverse Charge) on specified construction services. This will have a significant impact on accounting processes, and could affect the cashflow of businesses operating in the construction sector. Funders into the sector should be alive to the changes and engage with borrowers1 now to ensure that they, and their supply chain, are ready for the change.

How does it work?
Under the Reverse Charge regime the customer (i.e. the recipient of the supply) will be responsible for identifying whether a supply is subject to the Reverse Charge and if it is, for accounting to HMRC for the VAT that is due, rather than paying it to the supplier as would normally be the case. The Reverse Charge will generally only apply on services that are supplied to customers that also operate in the construction sector – so it will not apply where the customer is a consumer or an ‘end user’ of construction services, or the customer is not registered for VAT.

Why is it being introduced?
The Reverse Charge is being introduced to counter perceived fraud in the construction industry, where it is believed that suppliers are receiving VAT from customers and ‘disappearing’ before they account for the VAT to HMRC.

Which supplies does it apply to?
The Reverse Charge will affect supplies of building and construction services that are supplied at the standard or reduced VAT rates and are defined as construction operations under the Construction Industry Scheme (CIS), including those relating to:

• the construction, alteration, repair, extension, demolition or dismantling of buildings or structures;
• the installation of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure;
• painting or decorating the inside or the external surfaces of any building or structure; and
• site clearance, earth-moving, excavation, tunnelling and laying of foundations.

Impact on Business
On a practical level the introduction of the Reverse Charge will have an administrative impact and businesses will need to ensure their payment processes are updated and accounts teams are trained to implement the changes required by the new legislation.

Perhaps of more concern for those funding into the sector will be the impact of the Reverse Charge on the cashflow of borrowers and businesses in borrowers’ supply chains.

Many smaller contractors and sub-contractors operating in the sector currently rely on the VAT collected from customers as working capital before they pay it across to HMRC. Without putting plans in place to account for this loss in working capital, these businesses could be at risk of distress or failure with the consequent effect on the supply chain and delivery of projects.

How can funders prepare?
Ahead of the implementation of the Reverse Charge, funders into the sector should engage with borrowers to understand how the new regime will impact their business and the businesses of the borrower’s suppliers, including their contractors and sub-contractors. This will allow the funder to identify and take steps to mitigate any risks.

Practical steps funders can take now include:

• ensuring borrowers have modified their accounts processes to accommodate the new regime and ensure that there is minimal delay in the raising and collection of invoices as a result of the changes;
• understanding the extent to which borrowers currently rely on the VAT collected from their customers as working capital and how the new regime will impact the ongoing trading of a borrower’s business. To the extent that this analysis identifies risk, consider alternative support and funding arrangements to mitigate this exposure;
• understanding the extent to which borrowers have assessed whether any businesses in their supply chain may be adversely effected by the loss of working capital. If there are suppliers at risk, have borrowers considered the viability of amending payment terms and processes with that supplier to mitigate the risk of the new regime precipitating their failure with the consequent effect on the borrower’s own business?

The introduction of the Reverse Charge is one of a series of measures taken by HMRC to protect tax revenue. The partial reinstatement of crown preference from April 2020, which will elevate HMRC in the insolvency payment hierarchy for certain tax arrears, is also set to affect how funders analyse the risks of funding. These are two examples of where funders need to be alive to changes in tax law and how it could impact borrowers.

Source: Mondaq