The Government has prepared draft VAT legislation, expected to come into force from 1 October 2019, to tackle an estimated £100m tax loss in missing trader fraud.
This will mean sub-contractors in the supply chain will no longer be required to charge, collect and declare VAT. For sub-contractors this could mean simplified VAT accounting, but a reduced cash flow in their business of up to 20%. For larger firms there may be cash flow benefits, but increased accounting responsibilities.
What is the problem?
Missing trader fraud, also known as carousel fraud, has been around for 20 years. At its simplest form, a business is created and enters into a supply chain. Sometimes these supplies take place and on other occasions the whole supply chain is fabricated. At one point in the chain, VAT may be collected which is not remitted to HMRC. In addition, HMRC are concerned about businesses that register and reclaim input tax on projects that do not exist. By the time HMRC realise the fraud, the VAT repayments have been taken and the fraudulent parties have moved on.
What steps have the Government put in place?
Missing trader fraud is common across a number of sectors including mobile phone supplies, and gas and electricity commodity trading. HMRC introduced legislation to utilise a “reverse charge” to tackle this problem, and it is has been successful in these sectors. It is this legislation that will be extended to the construction sector.
What is the reverse charge?
Ordinarily it is the supplier in any transaction that is required to charge and account for VAT. The reverse charge moves this responsibility onto the customer. Essentially the supplier will only charge and receive the net amount, whereas the customer will charge itself VAT which it can then recover according to normal rules.
Let’s say that a subcontractor was due to charge £100k on a standard rated project. It would normally collect £20k as output tax and remit this to HMRC on its next VAT return. Following the changes, the subcontractor would only charge and collect £100k, and therefore any intent to ‘go missing’ would be avoided.
As for the contractor, they would have normally paid out £120k to the subcontractor, and reclaimed the £20k of input tax on its next VAT return. Following the changes, it would now only pay £100k and would charge itself £20k on its next VAT return. Assuming this relates to a taxable supply, and there is no partial exemption, then this £20k would be recoverable on the VAT return. This would therefore have a net nil effect on the return, and would effectively be a paper exercise.
As for fraudulent traders who fabricate supplies – they could normally make a claim stating that they had paid subcontractors say £120k, reclaiming £20k of VAT before disappearing. Following the change, there would be no VAT to pay or claim on the supply, which would prevent fraudulent claims from being made.
Want to find out more?
The draft legislation that has been published would see the reverse charge apply to ‘specified supplies’ of services. The type of services that are included and excluded are based on the definition of ‘construction operations’ and the rules that are currently in place for the Construction Industry Scheme.
We will be running a series of events across Scotland which will focus on the proposed changes and outline the practicalities of the new VAT accounting procedures, including:
- Details of what will be included and excluded from the change;
- Examples of the domestic reverse charge in practice;
- Cash flow benefits for the larger businesses;
- Cash flow challenges for the subcontractors; and
- What this means for your VAT accounting, and how cloud software can help.
To register your interest for these events please email firstname.lastname@example.org.
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This information should not be regarded as financial advice. This is based on our understanding in October 2018. Laws and tax rules may change in the future.