Domestic reverse charge VAT for construction explained, and what it quietly does to your cash

Four things have to be true at once. The work is a construction service covered by the rules. Both of you are VAT registered in the UK. The supply is reported under CIS. And your customer is not an end user or an intermediary connected to one.

The covered work is broader than most people assume. Building, altering, repairing, extending and demolishing, plus the installation of heating, lighting, air conditioning, ventilation, power, drainage, sanitation, water supply and fire protection systems. Painting and decorating inside or out. Site clearance, earth moving, excavation, foundations, scaffolding, landscaping and access works. Internal cleaning counts when it is part of construction, alteration, repair, extension or restoration. It does not cover drilling or extracting oil and gas on their own, or mineral extraction on its own.

The end user test is the one that trips people. A property developer, a landlord or a factory owner having work done on their own building is an end user, so you charge VAT in the normal way. The catch is that it is their job to tell you in writing and plenty of them never do. If you have not got that confirmation on file and you charged VAT anyway, you are the one holding the problem when HMRC asks.

HMRC’s own list is at gov.uk, and it is worth reading once properly rather than skimming.

Four mistakes come up again and again when we take on a construction company and look back through the sales ledger.

• VAT charged anyway. The subcontractor keeps invoicing with VAT because the software was set up that way years ago. The contractor pays it, reclaims it, and both sides now have a return that does not reflect what actually happened.
• The wording missing. The invoice has to state that the reverse charge applies and show the amount of VAT the customer needs to account for, or the rate. A line saying “reverse charge” and nothing else is not enough.
• Materials split out wrongly. Where you supply materials as part of the construction service, the whole invoice follows the reverse charge. Separating the materials onto a standard rated line is a common and avoidable error.
• End user status assumed. Somebody decided verbally that the customer was an end user. No written confirmation, no email, nothing on file.

None of these are dramatic on one invoice. Repeated across two years of subcontractor billing they produce returns that are wrong in both directions, and then a correction exercise nobody budgeted for.

If most of your sales are to other contractors, you are now charging almost no output VAT while still paying input VAT on materials, plant hire, fuel and overheads. That turns you into a repayment business. Money goes out to suppliers with VAT on it and comes back from HMRC a quarter later.

Two things follow from that, and most companies only do one of them.

The first is to move to monthly VAT returns. If you are in a repayment position there is no sense waiting three months for your own money. Monthly filing shortens the gap considerably and the extra filing work is minor once the bookkeeping is current.

The second is to get off the flat rate scheme if you are still on it. Reverse charge sales are excluded from flat rate turnover, which usually leaves the scheme doing nothing useful for you while you lose the input VAT you could otherwise reclaim. I have seen contractors stay on it for years after the rules changed because nobody raised it.

Both of these are five minute decisions once somebody actually looks. Neither happens on its own.

They overlap, so people treat them as one rule. They are two separate deductions and getting them confused is how money ends up stuck at HMRC.

CIS is a deduction from the labour element of a subcontractor’s payment, made by the contractor and paid over to HMRC against the subcontractor’s tax. The reverse charge moves the VAT accounting from supplier to customer. The reverse charge applies to supplies reported under CIS, which is why the two travel together, but they are calculated differently and reported in different places.

The practical consequence is on the invoice. CIS is deducted from labour only and materials are outside it. The reverse charge treatment covers the whole supply including materials. A subcontractor invoice can therefore have a CIS deduction on part of it and reverse charge treatment across all of it at the same time, which is exactly where the bookkeeping starts going wrong.

When both are wrong for a few years the result is predictable. We found over £100k sitting at HMRC for one construction client in the first meeting, from years of CIS and VAT returns filed incorrectly by the previous accountant. The company had taken a loan to cover costs while its own money sat there. That is not a rare story in this trade.

If you have read this far and recognised something, the question is what to do about the returns already filed.

Start by pulling your HMRC portal and your sales ledger side by side for the last two years. You are looking for sales invoices to VAT registered construction customers that carried VAT, purchase invoices from subcontractors where VAT was reclaimed that should have been reverse charged, and any end user treatment with no written confirmation behind it.

Errors can be corrected on a later return where they are within the limits HMRC sets, and disclosed separately where they are not. Which route applies depends on the size of the error and whether it was careless. Working this out before HMRC gets there is a materially better position than after.

The work is not complicated. It is tedious, and it needs somebody who knows what they are looking at going through the records line by line. Most of the value in a construction clean up comes from that one unglamorous exercise.