VAT changes taking effect from 1 October may cause significant financial disruption in the construction sector. The Federation of Master Builders (FMB) is warning that the implementation of the VAT domestic reverse charge for building and construction services from 1 October may ?cause chaos?. A recent survey by the FMB found that 69 per cent of construction SMEs have not heard of the reverse charge VAT. Of those that had, 67 per cent admitted they were not prepared for the changes. HMRC is currently planning to introduce the changes without a transitional period, despite the fact that they are predicted to have a significant impact on accounting practices and cashflow.

The measure aims to tackle VAT fraud in the construction sector, which is valued at £100 million a year. But the lack of awareness amongst the estimated 150,000 businesses affected, combined with the implementation coinciding with falls in construction activity and general business optimism in the UK, will prove a challenge for many construction SMEs - as well as those who lend to them.

What is the new VAT reverse charge? 

At the moment suppliers collect payments from their customers inclusive of VAT, and they are then liable to pay the VAT to HMRC through their VAT return, usually on a quarterly basis. The reverse charge will require customers rather than suppliers to pay the VAT element directly to HMRC through their own VAT return. The tax liability itself will not change, only the way it is accounted for.

What are the implications on the provision of finance?

Affected construction industry suppliers will no longer have the benefit of VAT collections in their bank accounts until they are due to HMRC. This will undoubtedly have an impact on the cashflow of many suppliers and could lead to an increased requirement for financial support, particularly through products such as invoice finance.

However, there might be some issues in relation to existing invoice finance facilities. Prior to the introduction of this regime an invoice financier would generally provide an advance (usually between 50 per cent and 85 per cent) against the value of the VAT-inclusive invoice. From 1 October they will only be able to provide an advance against the net value of an invoice. This could potentially lead to a reduction in the availability of funds of up to 20 per cent on new invoices raised.

At Pinsent Masons LLP, we have produced a helpful checklist for finance providers to use in managing this imminent change. The guide sets out areas for consideration, including the importance of undertaking due diligence to help identify those businesses that will be affected, areas of uncertainty, the importance in verifying invoice values, and a useful checklist for financiers.  

With only seven weeks to go before the changes take effect, it is important that every organisation potentially impacted by reverse charge VAT undertakes a full readiness and risk assessment.  Construction SMEs should also contact their finance providers to discuss the financial implications, especially cashflow, to minimise the potential for disruption.