Two Different Rules, One Confusing Name
Reverse charge VAT is one idea applied to two completely unrelated problems, and almost every argument we have with a client about it turns out to be the two versions being mixed up.
The first is the domestic reverse charge for construction, live since 1 March 2021. It exists because HMRC was losing money to fraud in building supply chains.
The second is the reverse charge on services bought from outside the UK, which has existed in some form for decades. It exists so that an overseas supplier does not have to register for VAT in every country its customers live in.
They share a mechanism and a name. They apply to different people, for different reasons, and they go on the VAT return differently. Get them confused and you will either file a wrong return or, more expensively, fail to spot that you should have registered for VAT at all.
This guide covers both, with the numbers, the invoice wording, the exact boxes, and the two traps that cost real money.
What the Reverse Charge Actually Does
Under normal VAT rules the supplier is the tax collector. They add 20 percent to the invoice, the customer pays it, and the supplier hands it to HMRC later.
Under a reverse charge, that job moves to the customer. The supplier invoices the net amount and charges no VAT. The customer works out the VAT that would have applied, declares it as output tax on their own return, and reclaims it as input tax on the same return.
For a business that can recover all its input VAT, the two entries cancel out and nothing is paid. That is why people describe it as VAT neutral, and why it can look pointless at first glance.
It is not pointless. It changes three things:
- The money never moves. VAT is declared and recovered on paper rather than passing from customer to supplier to HMRC. A supplier who was going to vanish with the VAT now has no VAT to vanish with.
- The cash flow moves too. The supplier loses the VAT they used to hold for a few months. We will come back to this, because it is the part that actually hurts.
- It is not neutral for everyone. If you are partly exempt, or on the flat rate scheme, or not able to reclaim input VAT for some other reason, the reverse charge produces a real cost rather than two cancelling entries.
The Domestic Reverse Charge for Construction
HMRC consulted on this in June 2018 and originally planned to start it on 1 October 2019. It was pushed back twice, once for a year because too few businesses had heard of it, then again because of the pandemic, and finally came in on 1 March 2021.
The problem it was built to solve is missing trader fraud. A supplier invoices for labour or materials, collects the 20 percent, and disappears without paying it to HMRC. The customer, who has done nothing wrong, still reclaims the VAT. HMRC estimated the loss in construction at up to £100 million a year and forecast that the reverse charge would protect £495 million of tax over five years.
When It Applies
All of these have to be true at once:
- The supply is of construction services covered by the Construction Industry Scheme.
- The supply is standard rated or reduced rated. Zero rated work, such as building a new dwelling, is outside it.
- Both parties are VAT registered in the UK.
- The customer is registered for CIS. Note that the supplier does not need to be.
- The customer is not an end user or intermediary supplier, or has not told you in writing that they are.
Miss any one of those and you charge VAT the normal way.
What Is In and What Is Out
The scope follows CIS fairly closely.
| In scope | Out of scope |
|---|---|
| Construction, alteration, repair, extension, demolition | Professional work by architects, surveyors and consultants |
| Installing heating, lighting, power, water, ventilation, drainage | Manufacturing building materials and components off site |
| Painting and decorating a building or structure | Making, delivering or hiring out plant with no operator |
| Site clearance, excavation, foundations, scaffolding erection | Installing seating, blinds, shutters and security systems |
| Roadworks, railways, docks, pipelines, power lines | Drilling for oil or gas, and mineral extraction |
| Internal cleaning during construction, alteration or repair | Signwriting and installing artistic works |
The awkward cases are the ones sitting on the line. Scaffolding erection on a building site is in scope, but hiring out scaffolding with no labour is not. Cleaning during a refurbishment is in scope, but the same cleaner doing a weekly office clean afterwards is not.
The End User Rule
An end user is a VAT and CIS registered business that receives construction services and does not make an onward supply of them. The obvious example is a property owner having its own building worked on. The whole point of the reverse charge is to protect the chain, and at the end of the chain there is nothing left to protect, so normal VAT resumes.
An intermediary supplier is connected to an end user, either through a shared interest in the land or through being in the same corporate group, and passes the services on without materially altering them. They are treated the same way.
Here is the part that trips everybody up. The end user has to tell you, in writing, that they are one. It can be by letter, by email, or written into the contract. If they say nothing, you apply the reverse charge.
We think HMRC got the default right and the mechanism wrong. Defaulting to the reverse charge is sensible, because silence should not create a fraud opportunity. But it puts the decision in the hands of the party with the weakest incentive to get it right. A developer who forgets to send the notification gets a reverse charged invoice and no cash flow penalty at all, while the subcontractor carries the consequences. In practice, if you are a subcontractor, chase the notification yourself and keep it on file per project. Nobody will do it for you.
Mixed Supplies and the 5 Percent Disregard
If your invoice includes goods as well as construction services, the whole thing is one supply for VAT purposes and the reverse charge applies to the full value of the invoice, materials included. There is no splitting it.
Running the other way, there is a relief. If the reverse charge element is 5 percent or less of the total value of the supply, it can be disregarded and the whole invoice is treated normally. Two conditions attach to it. Both parties must agree it applies from the start of the contract, and it is judged across the contract rather than invoice by invoice. Deciding quarter by quarter whether you fancy using it is not how it works.
What Your Invoice Must Say
A reverse charge invoice carries everything a normal VAT invoice carries, plus a statement that the reverse charge applies and that the customer is the one paying it. HMRC accepts wording such as:
- "Reverse charge: VAT Act 1994 Section 55A applies"
- "Reverse charge: S55A VATA 94 applies"
- "Reverse charge: Customer to pay the VAT to HMRC"
You must also show the VAT rate or the VAT amount that would have applied, clearly marked so it is obviously not being charged. That figure is there so your customer knows what to declare. Leave it off and you have handed them an arithmetic job they will probably get wrong.
How It Goes on the VAT Return
This is where most errors live, and it is worth being precise.
| Supplier | Customer | |
|---|---|---|
| Box 1, output VAT | Nothing | The VAT on the purchase |
| Box 4, input VAT | Nothing | The same VAT, reclaimed |
| Box 6, value of sales | Net value of the sale | Nothing |
| Box 7, value of purchases | Nothing | Net value of the purchase |
The box 6 line is the one to look at twice. Under the construction reverse charge the customer puts the VAT in boxes 1 and 4 and the value in box 7, and leaves box 6 alone. That is the opposite of the cross-border reverse charge, where the customer does put the value in box 6. Same name, different return.
Getting box 6 wrong does not change the VAT you pay, which is exactly why it survives. Nothing on the return looks wrong. It quietly inflates your declared turnover, which matters if you are anywhere near a threshold or if HMRC ever compares your box 6 total to your accounts.
Two other scheme points. You cannot use cash accounting for supplies covered by the reverse charge, though you can carry on using it for everything else. And the flat rate scheme, which deserves its own section below.
The Cash Flow Hit Nobody Costed
Before March 2021, a VAT registered subcontractor collected 20 percent on top of every invoice and held it until the return was filed and paid. Returns are due one month and seven days after the quarter ends, so money invoiced early in a quarter sat in the bank for over four months, and money invoiced late sat there for about five weeks. Across a full year, the average is roughly two and a half months.
Take a subcontractor turning over £240,000 a year, all of it now reverse charged. They used to invoice £288,000 and collect £48,000 of VAT. Holding that for an average of two and a half months means about £10,000 permanently sitting in the current account. Not profit, never theirs, but present, every single day, funding wages and vans and materials.
On 1 March 2021 that balance went to zero. Not gradually, and not with any transitional relief.
A great many small builders were using HMRC's money as working capital without ever framing it that way. The reverse charge did not take profit away from anyone. It withdrew a float from an entire industry at once, and most of the firms that struggled in 2021 had no idea that was what had happened to them.
It gets worse before it gets better. That same subcontractor still pays VAT on materials bought from a builders' merchant, because a merchant selling goods alone is not making a construction supply and charges VAT as normal. With £60,000 of materials a year, they pay £12,000 of input VAT and have no output VAT at all to set it against. They become a permanent repayment trader, sending money out and waiting for HMRC to send it back.
If that is you, two things are worth doing:
- Move to monthly VAT returns. You can apply through your online VAT account. It cuts the average wait for your repayment from around two and a half months to about six weeks. For the subcontractor above that is roughly £3,000 of cash pulled forward, permanently, for the cost of filing eight extra returns a year.
- Redo your cash flow forecast without the VAT float. If yours was built before March 2021, or copied from one that was, it is overstating your bank balance by a number in the thousands.
It Killed the Flat Rate Scheme for Subcontractors
This is the most expensive mistake we still find, five years on, and it is completely invisible from the outside.
The rule is that reverse charge supplies are excluded from flat rate turnover. You do not apply your flat rate percentage to them. Fine, in isolation. But the flat rate scheme's other rule has not gone anywhere: while you are on it, you cannot reclaim input VAT on ordinary purchases, apart from single capital assets over £2,000.
Put those together for a subcontractor whose customers are all other builders, and the result is grim.
A subcontractor on £120,000 of turnover, on the 9.5 percent building and construction services rate, used to do well out of the scheme. They collected £24,000 of VAT, paid HMRC 9.5 percent of £144,000 gross, which is £13,680, and kept the £10,320 difference. Giving up £4,000 of input VAT on £20,000 of materials still left them better off by over £6,000 a year.
After March 2021, with every sale reverse charged, the same business has no flat rate turnover at all. There is nothing for the percentage to apply to, so the scheme gives them nothing. And they are still on it, so they still cannot reclaim that £4,000 of VAT on materials.
£4,000 a year, handed to HMRC, for a benefit that no longer exists. Leaving the scheme turns that £4,000 into a repayment instead. Nothing on the VAT return flags this. The return simply shows small numbers and looks unremarkable.
If you joined the flat rate scheme before March 2021 and have not revisited it since, this is worth half an hour today. HMRC said at the time that construction businesses on the scheme should reconsider it. A lot of people did not read that sentence.
The Other Reverse Charge: Services From Abroad
Now the version that has nothing to do with construction.
When a UK business buys services from a supplier based outside the UK, the general business to business rule says the supply happens where the customer belongs, which is here. Section 8 of the VAT Act 1994 then treats you as if you had supplied those services to yourself. You declare the output VAT and, if you can recover input VAT, reclaim it at the same time.
This catches far more businesses than people expect. Advertising bought from an overseas platform, software and cloud subscriptions billed from another country, a designer or developer working from abroad, overseas legal or consultancy fees, stock photography, overseas commission on sales. If it is a service and the invoice comes from a non UK entity, it is probably in scope.
The first thing to check is always the invoice itself, not the brand on the website. The big platforms have moved their billing entities around repeatedly, and the same product can be billed from Dublin for one customer and from London for another. The company name and VAT number at the bottom of the invoice is what decides it.
The Trap That Forces You to Register
Here is the part almost nobody knows about, and it is the reason this section exists.
The value of reverse charge services you buy from abroad counts towards your VAT registration threshold. GOV.UK is explicit that taxable turnover includes services you received from businesses in other countries that you had to reverse charge. You can be liable to register for VAT because of what you have bought, not what you have sold.
Take a freelance designer, not VAT registered, billing £78,000 a year to UK clients. Comfortably under the £90,000 threshold, or so it looks. Over the same year they spend £9,000 on advertising billed from Ireland, £3,500 on software subscriptions billed from the United States, and £1,500 on an overseas subcontractor.
That is £14,000 of reverse charge services. Added to £78,000, their taxable turnover for threshold purposes is £92,000, and they crossed the line at some point during the year without noticing. Registration was compulsory within 30 days of the end of the month it happened in, and HMRC will want the VAT on sales made since the effective date whether or not it was ever charged to the client.
This is a live risk for exactly the kind of businesses that spend heavily on overseas platforms while still being small: influencers and creators, ad funded websites, agencies, ecommerce sellers, app developers. If you are within about £15,000 of the threshold and you spend real money on overseas services, add them up before you assume you are safe.
How It Goes on the Return
Assuming you are registered, the customer enters:
- Box 1, the output VAT on the deemed supply
- Box 4, the same amount reclaimed, if you can recover input VAT
- Box 6, the value of the services
- Box 7, the value of the services
Boxes 6 and 7 both. That is the difference from the construction version, where box 6 stays empty for the customer. If you deal with both kinds of reverse charge, and plenty of construction businesses do once you count their software subscriptions, the two need separate tax codes in your bookkeeping rather than one catch all.
What Goes Wrong Most Often
From the returns we have taken over and corrected, in rough order of frequency:
- The wrong box 6 treatment, in both directions, usually because a single software tax code is being used for both reverse charges.
- Reverse charging an end user because the notification was never requested, so a property owner gets an invoice with no VAT on it and no way to reclaim anything.
- Charging VAT normally to a contractor who should have been reverse charged, which leaves the contractor reclaiming input VAT they were never entitled to. HMRC can recover that from the contractor, not the supplier who made the error.
- Splitting an invoice between materials and labour to keep the materials out of the reverse charge. One supply, one treatment, whole invoice.
- Staying on the flat rate scheme after the sales that made it worthwhile stopped existing.
- Still using cash accounting for reverse charge supplies, which is not allowed and quietly moves your tax points to the wrong period.
- Applying the 5 percent disregard invoice by invoice rather than agreeing it at the start of the contract.
Our Honest Take
As a fraud measure, the construction reverse charge worked, and honest subcontractors paid for it. HMRC protected its £495 million. The bill was settled by every compliant firm in the sector losing its VAT float on the same Monday morning in March 2021. Fraud measures usually cost the compliant something in admin. This one cost them cash, and at a scale nobody outside the trade seems to have noticed.
The name is the real problem. Two rules that behave differently on the return should not share a label. We would happily see the construction version called something else entirely. Until that happens, the practical defence is separate bookkeeping codes and a bookkeeper who knows why they are separate.
Registration is a worse deal than it used to be for labour only subcontractors. Before 2021, being VAT registered bought you a cash float and input VAT recovery. For a labour only subcontractor working solely for other builders, the float is gone and there is very little input VAT to recover. What is left is quarterly filing and Making Tax Digital record keeping for no gain. We are not suggesting anyone suppress turnover to stay under the threshold, and voluntary registration still makes sense where materials are significant. But the calculation genuinely changed in 2021, and if you registered voluntarily years ago it is fair to ask whether you would make the same choice today.
Check your invoices from overseas platforms once a year. Billing entities move. A supplier that charged you UK VAT last year may be invoicing you from abroad this year, which changes your treatment and, if you are close to the threshold, possibly your registration status. It takes ten minutes and it is the single cheapest piece of VAT housekeeping there is.
How IAK Can Help
We handle VAT for construction businesses and growing companies across North London and Hertfordshire, and the reverse charge is a large part of that work. For construction companies and contractors we set the invoice wording and tax codes up correctly, chase and record end user notifications, run the flat rate comparison properly against reverse charged turnover, and move clients to monthly returns where they have become repayment traders.
For everyone else, we check overseas supplier invoices against the registration threshold before it becomes a problem rather than after. That one check has kept more than a few clients out of a backdated registration.
If you are a subcontractor who has never revisited the flat rate scheme since 2021, a small business spending heavily on overseas software and advertising, or a business that simply wants someone to confirm the boxes are right, get in touch. Our VAT calculator will give you the gross and net figures in the meantime.
Sources
- Check when you must use the VAT domestic reverse charge for building and construction services, GOV.UK, for the list of services in and out of scope and the requirement that supplies be reported under CIS.
- VAT domestic reverse charge technical guide, GOV.UK, for the end user and intermediary supplier definitions, the written notification requirement, the 5 percent disregard, invoice wording, the single supply rule for goods with services, the exclusion of reverse charge supplies from the flat rate scheme and the bar on cash accounting.
- VAT registration: when to register, GOV.UK, on the £90,000 threshold and on taxable turnover including services received from businesses in other countries that you had to reverse charge.
- Place of supply of services (VAT Notice 741A), GOV.UK, for section 8 VAT Act 1994, the business to business general rule that services are supplied where the customer belongs, and the requirement to add reverse charge services to your own taxable supplies when testing registration.
- Anti-fraud measure for VAT: moving forward with the domestic reverse charge for the construction sector, Tax Adviser, on the June 2018 consultation, the two delays and the missing trader fraud the measure targets.
- Reverse charge procedures: some common pitfalls, Tax Adviser, on the builder to builder scope and the VAT return treatment.
- Domestic reverse charge VAT: how it works, BDO, on specified services between VAT registered businesses and onward supplies.
- VAT Flat Rate Scheme: work out your flat rate, GOV.UK, for the 9.5 percent building and construction services sector rate used in the worked example.