How to understand the VAT domestic reverse charge

What you need to do

The VAT Domestic Reverse Charge (DRC) is a rule that changes who pays VAT to HMRC for certain construction services. Instead of you, the supplier, charging and collecting the VAT, the responsibility shifts to your VAT-registered customer. Your invoice must show the VAT amount, but you don't collect it. Instead, you must include a note stating that the reverse charge applies, and your customer pays the VAT directly to HMRC on their own VAT return.

This rule was introduced to combat fraud in the construction sector. While it might seem complicated at first, it becomes straightforward once you understand when it applies and how to adjust your invoicing.

What is the VAT Domestic Reverse Charge?

Think of it as switching the VAT payment responsibility. Normally, you provide a service, add 20% VAT to your invoice, collect the total from your client, and then pay the VAT portion to HMRC later. Under the DRC, you still note the 20% VAT on the invoice, but you don't collect it. Your client pays you only for your services, and they handle the VAT element themselves by declaring it on their own VAT return.

When does the reverse charge apply?

You must use the reverse charge when you meet all of the following conditions:

• Your service is a 'specified service' for construction that falls under the Construction Industry Scheme (CIS).
• The supply is made at a standard or reduced rate of VAT. It doesn't apply to zero-rated services.
• Both you (the supplier) and your customer are registered for VAT in the UK.
• Your customer is not the 'end user' of the service.
• Payment for your service is reported through CIS.

What is an 'End User'?

This is the most important concept to understand. An 'end user' is the final customer who receives the construction service and does not sell that service on to another party. For example, a homeowner having an extension built or a retail business having their shop refurbished are end users.

If your customer is the end user, the reverse charge does not apply, and you should invoice them with VAT in the normal way.

Your customer has a legal duty to inform you in writing if they are an end user. If they don't tell you otherwise, you should assume the reverse charge applies. It's good practice to always ask your clients about their end user status before you start work to ensure your invoicing is correct.

What services are covered?

The reverse charge applies to most services in the construction industry that are also covered by the CIS. This includes, but is not limited to:

• Construction, alteration, repair, extension, or demolition of buildings.
• Installation of systems for heating, lighting, power, water, and ventilation.
• Painting and decorating.
• Groundworks and landscaping.

Services like those of architects and surveyors, and the hire of machinery without an operator, are not covered. For a definitive list, always check the guidance on the GOV.UK website.

How to create a reverse charge invoice

When the reverse charge applies, your invoice must be different from a standard one. It must include all the usual information, but with these key changes:

1. Show the VAT amount: Calculate the VAT on the service as you normally would (e.g., at 20%), but do not add it to the final total that the customer has to pay.
2. Make a clear note: You must add a reference on the invoice to make it clear that the reverse charge applies. The wording recommended by HMRC is:

   "Reverse charge: VAT Act 1994 Section 55A applies."

3. State the VAT to be paid: The invoice should clearly state how much VAT is due under the reverse charge, or the rate of VAT if the amount cannot be shown, but that this VAT is not to be paid to you.

For example, for a £1,000 job, your invoice would show £1,000 for your services plus £200 VAT, but the total amount due from the customer would only be £1,000.

How does it affect your VAT return?

As the supplier, you still need to account for the sale on your VAT return:

• Box 6 (Total value of sales): Include the net value of the sale (e.g., £1,000 in the example above).
• Box 1 (VAT due on sales): Do not include the VAT from the reverse charge sale in this box.

Tips for managing the reverse charge

• Check your software: Ensure your accounting software (like Xero, QuickBooks, etc.) is set up to handle DRC invoicing and VAT returns correctly. Most modern systems have this feature built-in.
• Manage your cash flow: Because you are no longer receiving the VAT element from some customers, your cash flow may be reduced. Factor this into your financial planning.
• Communicate clearly: Always confirm with new commercial clients whether they are VAT registered and if they are the end user before you issue your first invoice. Getting this confirmation in an email can prevent future disputes.