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Delay in Reverse Charge VAT implementation provides opportunity for construction sector to get prepared

Reverse Charge VAT requires urgent action

Reverse charge VAT may have a material impact on cash flows throughout the construction sector supply chain - have you considered how to mitigate the impact?

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Headshot Stephen Absolom

Partner, Restructuring

KPMG in the UK

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Delayed implementation of reverse charge VAT provides a golden opportunity to get fully prepared.

The proposed reverse charge for construction services is arguably one of the most significant changes in British VAT legislation in recent years.

The operational and financial impact on businesses throughout the building supply chain should not be underestimated. Such is the size of the change that HMRC announced a twelve-month postponement to the policy implementation, in September 2019, citing widespread industry concerns around sector readiness.

When the rules are eventually actioned reverse charge VAT has the potential to place significant additional cashflow pressure on businesses that are already under significant financial stress.

This twelve-month reprieve is a perfect opportunity to prepare properly and make suitable working capital improvements to mitigate the worst of any adverse liquidity.

Why the change?

The objective of reverse charge VAT is to eradicate so-called missing trader fraud. It seeks to prevent unscrupulous subcontractors within complex supply chains charging VAT on their supply to customers but then failing to pass the VAT over to HMRC.

From 1 October 2020, the customer will pay VAT directly to HMRC, instead of the supplier of the service, reducing the opportunity for VAT to ‘go missing’ somewhere in the supply chain.

Reverse charge turns the core principle of VAT on its head, in that VAT no longer ‘flows’ through the supply chain as ‘value’ is added to a product or service. It requires, amongst other things, the ‘end user’ to be clearly identified in all account documentation, as this entity will now be liable to pay over the total amount of VAT liable on any given supply. Further details are provided by HMRC here.

Reverse charge is not a new idea - it has already been deployed in very specific sectors such as mobile phone imports where similar fraud had been detected. The difference between this and previous implementations of reverse charge VAT is the sheer number of businesses likely to be impacted. HMRC estimate that up to 150,000 construction related businesses could be subject to reverse charge VAT.

What is the impact on the sector?

Although HM Treasury expects to gain £100m a year from reduced levels of tax evasion, for businesses complying with the current rules the change is cost-neutral – the same amount of VAT will be paid across to HMRC under reverse charge as is paid today.

The impact on subcontractors is therefore two-fold.

The first is the short-term practical challenge of shifting across from one system to another. Understanding who the ‘end users’ are in any particular supply may not always be straightforward and requires each entity understanding their own role within the chain and how suppliers and customers all fit into the bigger picture. Having accounting systems, processes and personnel familiar with the new rules will be essential to avoid costly errors.

The second impact, and perhaps one which is more difficult to overcome, is that the as-yet unpaid VAT will no longer act as a form of short-term working capital. Under the conventional VAT regime, businesses making quarterly VAT returns may hold onto the tax charged to the customer for up to four months before paying it across to HMRC. Many contractors have historically used this cash to effectively support their immediate cash requirements. Under reverse charge, that cash is instead paid directly from the customer to HMRC, meaning it never touches the contractors’ bank account and is unavailable to support their day-to-day liquidity.

The impact is worse for businesses who use invoice discounting, as funding will instead be applied to the net value of goods, not the gross amount.

Practical Implications for Contractors

  • Ensure that the CIS register is up to date for subcontractors
  • VAT to CIS subcontractors should be withheld for any purchases after 1 October 2020
  • Withheld VAT will be included on future VAT returns
  • The new regime could result in contractors moving from a VAT reclaim to a VAT payment position
  • Contractors need to ensure accounting systems are in place to reflect the change in VAT accounting

Practical Implications for Subcontractors

  • Invoices will only be paid net of VAT from 1 October 2020, potentially impacting the cash available in the business
  • Funding from Invoice Discounting or Factoring will be on the net value of invoices, not the gross value, exacerbating the cash impact
  • The new regime could result in the business moving from a VAT payment to a VAT reclaim position
  • If the business is a contractor to other subcontractors then the implications for the rest of the supply chain must be considered

What can businesses do?

The twelve-month deferment is a perfect opportunity for construction businesses to get their ‘house in order’ and find alternative financing arrangements. It’s also an ideal time to understand how the working capital requirement of the whole business can be reduced, bringing down financing costs and potentially improving operational efficiency in the process.

Mitigating actions may include:

  • Renegotiating payment terms with customers given their improved cash position further along the supply chain
  • Reviewing whether more of the supply chain can be subcontracted, thereby obtaining the cash benefit from withholding VAT
  • Reviewing stock levels, payment processes and cash management processes in order to smooth cash cycles

How can KPMG help?

At KPMG Restructuring we have a team of sector experts based across the UK ready to help businesses facing this situation. We have extensive experience supporting construction businesses of all sizes to respond to sudden liquidity challenges and identify opportunities to enhance working capital throughout their operation.

We believe it’s possible to improve working capital performance by up to 15% using a range of measures, which when actioned can help to mitigate the cash impact of reverse charge VAT. These can be identified through our proprietary benchmarking and hypothesis validation and realised through detailed planning and implementation. Our approach takes a holistic approach to cash improvement, not just focusing on working capital – we place cash improvement at the heart of your business strategy and drive sustainable change through robust processes, improved visibility and control.

If you would like to talk to us about preparing for reverse charge VAT in 2020, please get in touch.

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KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

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