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Budget's VAT overhaul: All you need to know

Robert Facer

Chancellor’s crackdown on so-called ‘missing trader’ tax fraud requires contractors to take practical steps ahead of its implementation.

VAT fraud has long been an issue in the construction sector and earlier this year, a government consultation revealed that tens of millions of pounds have been ‘lost’ in tax revenue due to this unlawful activity.

In last week’s Budget, the chancellor announced a crackdown on so-called ‘missing trader’ fraud, which is prevalent in construction. Specifically, Philip Hammond announced plans to change the way VAT is accounted for when a subcontractor supplies labour to a project.

Under normal circumstances, the subcontractor supplying labour to a project would charge a contractor an additional 20 per cent to cover VAT, before filing and paying the tax. As long as the contractor is a VAT-registered business, they would then have the opportunity to reclaim an equivalent amount directly from HMRC on submission of their quarterly VAT return.

How the old system was abused

However, while this is in theory a relatively efficient process, placing tax obligations on subcontractors has created an opportunity for some operators to abuse the system by evading paying VAT on labour.

While contractors would pay their supplier an additional 20 per cent, under the illusion it would then be sent directly to HMRC, fraudulent subcontractors were found to be keeping the full balance and then disappearing from view before HMRC had the chance to chase up the missing tax.

This practice has been exacerbated by the often long and complicated supply chains associated with large projects, which allow fraudsters to be lost in a tangle of contractors and suppliers.

“It is likely that we will see new invoicing requirements and additional reporting obligations for contractors and subcontractors”

Currently, HMRC has to assess the culpability of the defrauded contractor on a case-by-case basis, to determine if the claim for the VAT they have paid should be granted. If they are deemed to have acted responsibly, without prior knowledge of the subcontractor’s intention to embezzle the funds, they should be able to reclaim their tax payment in full as usual. This is where HMRC loses out, as it ends up paying out rather than receiving the VAT payments due.

New VAT system explained

The new rules set out by the chancellor, which are expected to come into force in October 2019, will see the supplier of the labour essentially cut out of the tax process entirely, in what is known as a ‘reverse-charge’ rule.

Rather than paying the subcontractor the 20 per cent VAT owed, contractors will instead file the necessary tax payments themselves, while also reclaiming them on the same return. Effectively, this cuts the subcontractor out of the loop of tax payments and means ‘missing trader’ fraud will no longer be possible.

This is good news for both HMRC and contractors. However, there are still certain practical steps that contractors should take in preparation for the changes in just under two years’ time.

What contractors should do

Contractors should wait for guidance and make sure they understand what their new responsibilities will be from October 2019. While we can’t be certain at this stage, it is likely that we will see new invoicing requirements and additional reporting obligations for contractors and subcontractors.

Getting to grips with what the new system may bring may involve reviewing how other reverse-charge systems operate. For example, similar systems are already used by wholesalers of mobile phones, computer chips and other similar high-value goods.

Of course, the precise details won’t be clear until HMRC publishes full guidance on the matter, which could take a while to prepare. Until then, the industry can be assured that this issue is being addressed and stay on the look-out for potential scams in the run-up to the new legislation’s implementation.

Robert Facer is VAT director at accountancy firm Menzies

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