VAT in the construction sector can be intricate, and many businesses face challenges in understanding its complexities. For contractors, subcontractors, and business owners alike, mastering VAT application is essential. Errors can lead to substantial financial penalties and reputational harm. You can ensure compliance and protect your bottom line by steering clear of common VAT pitfalls.
1. Incorrect VAT Classification of Services
One of the most common VAT mistakes in the construction industry is misclassifying services. Whether a project is a new build, renovation, or repair determines the VAT rate that should be applied. Misapplying the rate can lead to overcharging clients or underreporting VAT to HMRC, resulting in significant financial repercussions that are best avoided.
Real-Life Example:
A construction company was hired to complete a project involving new construction and renovating an existing structure. The company mistakenly applied the standard 20% VAT rate to the entire project instead of the zero-rated VAT for the new build section. This resulted in overcharging the client and considerable embarrassment when challenged by the client’s accountant.
Real-Life Example:
- Clearly distinguish between new builds, renovations, and repairs. A new residential build is generally subject to a 0% VAT rate, while repairs and renovations are subject to the standard 20% rate
- Consult with your accountant to ensure that the correct VAT rates are applied based on the type of work being carried out. Their expertise can give you confidence that you’re making the right decisions for your business.
2. Failure to Apply VAT on Labour and Materials Separately
Some construction businesses believe that VAT should be charged differently based on the material or labour costs, but this isn’t the case. The VAT application process is straightforward, and there is no requirement to split materials and labour on an invoice for VAT purposes. The VAT should simply be applied to the total value of the invoice, regardless of the split between labour, materials and mark-up.
How to Avoid This Mistake:
- Ensure that VAT is applied to the total value of your invoice. There is no legal requirement to separate VAT on labour from VAT on materials for invoicing purposes.
If you are subject to CIS deductions, showing the split between labour and materials on your invoices is good practice, as only the labour element is taxed at 20%.
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3. Not Using the Domestic Reverse Charge Correctly
The Domestic Reverse Charge (DRC) is one of the most misunderstood VAT rules in the construction industry. The DRC shifts the responsibility for VAT from the supplier to the buyer for certain construction services. However, many construction businesses either fail to understand when the DRC applies or miss it entirely, leading to serious financial liabilities that are avoidable with proper understanding and application of the rule.
Real-Life Example:
A contractor provided construction services to another VAT-registered business but failed to apply the Domestic Reverse Charge, assuming VAT should be charged as usual. As a result, the contractor was liable for VAT that should have been accounted for by the customer, turning their VAT refund into a VAT payment.
How to Avoid This Mistake:
The Domestic Reverse Charge applies to certain types of building work where both parties (the contractor and customer) are VAT-registered. The key is ensuring the buyer and seller understand when the reverse charge applies. The rule applies to services such as construction and demolition work, and to materials if they are supplied as part of a contract that falls under DRC.
Additional Advice:
It’s crucial to ensure that your invoices are marked correctly when the Domestic Reverse Charge applies, not only with the correct calculation of VAT, but also with the correct accompanying wording. If you are uncertain whether the reverse charge applies to a particular project, consulting with an accountant is best. Misapplication of the DRC can lead to penalties from HMRC, and delays in receiving payment from your customer if they need to raise queries on the invoice.
4. Failing to Submit VAT Returns on Time
Missing VAT return deadlines can happen to even the most organised businesses. HMRC’s penalty system for late submissions is now more stringent, and a new penalty points system has been introduced to encourage timely filing. Meeting submission and payment deadlines avoids penalties and maintains a good relationship with HMRC.
The New Penalty Points System:
Under the new system, businesses will accumulate penalty points for late submissions of VAT returns. Once a certain threshold is reached, companies will incur financial penalties. This system is designed to incentivise businesses to file and pay their VAT by the required deadlines, reducing the risk of repeated late submissions.
How to Avoid This Mistake:
- Create a Business Gateway account with HMRC to track upcoming VAT returns and other liabilities. This account provides a centralised view of your tax affairs and helps you stay on top of deadlines. You can also add other taxes to have a complete picture of all your due dates.
- Consider using accounting software that integrates with HMRC’s systems to help automate VAT return submissions. This reduces the risk of human error and ensures that your returns are filed on time.
5. Not Claiming VAT on All Eligible Expenses
Many construction businesses fail to claim VAT on eligible expenses, missing out on the potential to reduce the VAT they owe. These expenses include materials, tools, and even utilities that are used for business purposes.
Real-Life Example:
A contractor regularly purchased building materials and machinery for their business but neglected to claim back VAT on certain purchases. Over time, this added up to significant lost VAT refunds.
How to Avoid This Mistake:
- Review all your business expenses regularly to ensure that VAT is being reclaimed where eligible.
- Tools, materials, and even fuel for business vehicles are common items eligible for VAT reclamation. If they are used exclusively for business purposes, you may also be able to reclaim VAT on items like office supplies or work uniforms.
- Remember that, depending on the nature of the work, you can also reclaim VAT on certain operational costs, such as subcontractor fees.
Practical Tips:
- Keep Detailed Records: The best way to avoid VAT mistakes is to keep thorough, organised records of all your transactions. This will help you during VAT reviews and ensure you’re claiming the right amount of VAT.
- Use Specialist Accounting Software: Accounting software designed for the construction industry will help you seamlessly track VAT, send accurate invoices, and generate VAT returns. Always attach an image of the receipt or invoice to the transaction in your accounting software.
- Consult with VAT Experts: The construction industry has specific VAT regulations, and seeking expert advice is essential when in doubt. An accountant can help you understand the complex rules around VAT in construction and make sure you’re always compliant.
- Stay Updated on VAT Rules: VAT rules for the construction industry change from time to time. Keep up-to-date with the latest regulations from HMRC to ensure you are always compliant.
- Regular VAT Audits: Periodic reviews of your VAT records can help identify missed claims or potential errors before they become a problem. Reclaiming VAT in error on an expense is easily resolved if it’s picked up after a few months—if it’s not picked up for a few years, it can have turned into quite a surprise bill.
VAT compliance in the construction industry doesn’t have to be overwhelming. You can reduce the risk of costly errors and penalties by avoiding the common mistakes outlined in this blog and staying vigilant about the rules. Whether it’s ensuring correct VAT classification, understanding when the Domestic Reverse Charge applies, or simply staying on top of your VAT deadlines, BBK Accounts is here to help you easily navigate the complexities of VAT.
If you need assistance with your VAT returns or want to ensure compliance across your business, get in touch with BBK Accounts. We specialise in VAT compliance for construction businesses and have various services to ensure your financial records are up-to-date and accurate.
