Planning ahead for the domestic reverse charge for construction

Most of our clients will now be aware of the new VAT domestic reverse charge for construction legislation (hereinafter referred to as DRC in this article), will come into force on 1 October 2019.

Latest update on labour supply by an employment business

Recently, we have explained that HMRC had clarified that the provision of labour to a construction site by an employment business/agency, where the labour supplied comes under the supervision of the site, did not come under the DRC even if it was to be reported under CIS. The question of labour supplied by other employment intermediaries, umbrella companies, personal service companies and the like was at that stage unclear. One might have assumed that if an employment business has a contract with a personal service company for the provision of construction services and a contract with their client to supply construction services that this would be under the DRC for both the supply to the employment business and for the supply by the employment business, with that business being regarded as an ‘intermediary’ (defined in section 2 of the draft statutory instrument) under the definition of the legislation.

We now have written confirmation from HMRC that they would not view this as being a supply of construction services by the employment business and therefore it would not come under the DRC.  This means that for the purpose of the new legislation an employment business will be treated as an ‘end user’ (as defined in section 2 of the draft statutory instrument). Therefore, supplies to the employment business will not be under the DRC rules, with the supplier charging and accounting for VAT in the normal way, and supplies from the employment business to their client also will not be under the DRC rules, so they will charge VAT to the client in the normal way and account for it as output tax to HMRC.

At first sight this may seem to be good, even if surprising, news for employment businesses – the new rules do not affect them. However, there is a sting in the tail.  Whilst there is the benefit of clarity and no need to make changes to recording and invoicing systems to adopt the DRC, the employment business loses the protection of the reverse charge system and thus will be open to being unwittingly caught up in a fraudulent chain of supply and open to being held liable by HMRC for VAT unpaid by others under the joint and several liability principles, which means there is a great need to ensure due diligence is at an appropriate level to protect these businesses.

So, with this clarity, let us consider how clients both in construction businesses and in employment businesses should be preparing for the DRC.

Businesses in the construction industry

A business making supplies of construction services will need to consider both to whom they are making supplies and from whom they are receiving them and how the DRC rules will affect those supplies. Preparation for the new legislation will need to cover a range of matters including reviewing contracts for supply, checking accounting and invoicing systems and their ability to deal with the DRC, control checks on VAT rates charged and whether VAT should have been charged at all, the impact of the DRC on cash flow and ensuring due diligence is at an appropriate level for supplies that come within the scope of joint and several liability.

Employment businesses

As mentioned above, it would be tempting for an employment business to think there was no need to make any preparations for the upcoming DRC rules as their supplies will not come under the legislation, not being viewed as a supply of construction services.  However, that would overlook some of the very real risks of making supplies in a chain of specified supplies that come under the joint and several liability rules. As a supply to an employment business will not be under the DRC, employment businesses will need to prepare themselves most certainly by enhancing due diligence policies and procedures to protect themselves from becoming liable for fraud elsewhere in the supply chain.

The effect of the joint and several liability rules and due diligence

You will have noted several references to joint and several liability rules and due diligence in this article.  The joint and several liability rules are set out in the VAT Act 1994 and section 77A.  This sets out that where a taxable person operates in a chain of ‘specified supplies’, he can be held liable for tax that has not been paid to HMRC as a result of fraud within the chain.  A number of court cases have addressed this matter and to what extent a taxpayer may be held liable for the fraudulent activity of others within his supply chain.

One of the important cases is the Kittel v Belgium case which has established the principle (the Kittel principle) that where a taxpayer ‘knew or should have known’ that his transactions were in a chain connected with the fraudulent evasion of VAT, then he can be held liable for missing tax in that chain of supply.

Under the DRC rules, supplies in the construction chain are being added to the ‘specified supplies’ covered by section 77A.  Hence the need for an urgent review of due diligence policies and procedures for businesses whose supplies are directly those of construction services, or those who are supplying labour into the chain which contains construction services.  It may instinctively feel ‘wrong’ that a taxable person can be held liable for the fraudulent activity of others, but the law has established the principle that if the taxpayer has information which is available to him, and either does not bother to acquire that information, or does not take appropriate action when he has found the relevant information to ensure that he is not within a fraudulent supply chain, then he can be made liable for the tax loss.  This means that it is vital to ensure that all the right foundations are in place and in action for this enhanced due diligence ahead of the introduction of the DRC in October.


With MTD for VAT commencing in just over a month and the DRC commencing in October, this is going to be a busy six months or so for VAT registered businesses to ensure full VAT compliance. As you can see from this article, there is significant preparation to be done for the DRC change in October, and, as there will be some big changes coming in for April 2020 for many of our clients with respect to IR35 in the private sector and a variety of employment-related changes, it will be vital to use the time between now and October to be fully ready for the DRC, with systems bedded in and working well, so that the time from October can be used to become fully prepared for the April 2020 changes in other areas.

With two significant changes in VAT, it is perhaps a good time for VAT registered clients to consider having a ‘VAT health check’ during the next 6 months to check on all areas of application of VAT legislation and the accounting records that affect compliance with the legislation. It is reasonably easy to summarise in a sentence or two the type of preparations that may be needed for the arrival of the DRC, but one cannot overemphasise the significant amount of work to be done for businesses to be ready, nor the time that will take. In addition to a possible VAT health check, there are a variety of ways in which Chartergates can support their clients specifically with preparing for the practical application of the domestic reverse charge for construction services and we will soon be mailing our VAT retainer clients  with more detail on the services we can offer to help you to navigate these choppy waters. Those with no VAT retainer who may want further advice or support can of course contact us direct for more information about those services.

Published: 05.20.19 - Posted In: Latest News