VQOTW: Flat rate scheme interaction with the domestic reverse charge for construction

My client is a builder who works mainly as a sub-contractor for other VAT and CIS registered building firms. They are registered for VAT on the flat rate scheme as they are predominantly labour-only. Due to the introduction of the domestic reverse charge for construction on 1 March 2021, I am concerned that my client should have left the flat rate scheme from that date? 

Within their domestic reverse charge technical guide, HMRC only briefly mention flat rate scheme treatment for supplies falling under the domestic reverse charge. Section 13 states:

  1. Flat rate scheme

Reverse charge supplies are not to be accounted for under the scheme. Flat Rate Scheme users who receive reverse charge supplies will have to account for the VAT due to HMRC and recover it simultaneously on the same VAT Return.

Users of the Flat Rate Scheme will have to consider if it’s still beneficial to them bearing in mind that under the scheme they cannot recover VAT incurred on purchases of materials, overheads and so on.

So why are they excluded and how does this work in practice?

The legislation for the domestic reverse charge was inserted into Section 55A VATA1994 (alongside existing MTIC supplies). The legislation for the Flat Rate Scheme in Section 55C(6) VAT Regs 1995 states:

“55C(6)  Where a supply of goods or services to which section 55A(6) of the Act applies (customers to account for tax on supplies of goods or services of a kind used in missing trader intra-community fraud) is made to, or made by, a flat rate trader, that supply is neither a relevant purchase nor a relevant supply of his.”

Therefore, supplies made and/or received under the domestic reverse charge are not relevant supplies or purchases and so they should be dealt with outside the scheme.

This does not mean that a trader must leave the scheme, although I will move on to explain why it may be beneficial to do so.

If the client acts only as a sub-contractor and all their sales will now be subject to the domestic reverse charge then it makes sense to leave the scheme, as they will no longer have any output VAT to account for (as these supplies are excluded from the flat rate scheme turnover) but by remaining on the flat rate scheme they continue to be blocked from recovering input tax on materials and overheads, etc.

Building clients who are on the flat rate scheme but make supplies to end users (i.e. their supplies don’t fall within the scope of the domestic reverse charge) are largely unaffected by remaining on the flat rate scheme. They will continue to charge VAT as normal and include the gross value of the supply in their flat rate turnover. If they receive supplies from sub-contractors that are subject to the domestic reverse charge, because these are not relevant purchases, as referred to above, they account for the reverse charge outside of the scheme in Box 1, Box 4 and Box 7 on the VAT return.

As they are not relevant purchases input tax can be claimed in Box 4 in line with normal input tax rules.

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VAT Adviser
0844 892 2470

Tony joined HMRC in 2015 where he managed a cross-tax Hidden Economy team specialising in failure to notify compliance work and evasion. He developed a sound understanding of VAT as well as gaining significant knowledge of the compliance penalties regime and Schedule 36 compliance powers.

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