Tony Cochrane, Chartered Tax Adviser and Associate of the Institute of Indirect Taxation and is a director at VITA
This View has been written by Tony Cochrane is a Chartered Tax Adviser and Associate of the Institute of Indirect Taxation and is a director at VITA.
The construction sector has lived with the VAT Domestic Reverse Charge (“DRC”) since March 2021, but lately, HMRC’s attitude towards compliance has changed dramatically.
What began as a regime introduced to combat VAT fraud, with a promise of “light‑touch” enforcement, is now an area where HMRC teams are actively identifying errors, issuing assessments, and applying penalties with increasing confidence.
Many honest contractors and subcontractors are still grappling with the rules, and HMRC has clearly run out of patience. For businesses operating anywhere in the construction supply chain, now is the moment to get DRC compliance in order.
So, what exactly is the VAT Domestic Reverse Charge? In short, the DRC shifts the VAT accounting obligation from the supplier, typically the subcontractor, to the customer, typically the contractor, but only where certain conditions are met.
Under the DRC the subcontractor invoices without VAT, reporting only the net sale. The contractor accounts for VAT on their own VAT return, both the output and input VAT, and records the net purchase as normal. This mechanism was introduced as an anti‑fraud measure within supply chains considered high‑risk by HMRC.
The DRC applies when all the following conditions are satisfied:
– Supplier and customer are UK VAT‑registered
– The supply is standard‑rated or reduced‑rated
– The work is within the Construction Industry Scheme (CIS)
– The customer is registered for CIS
– The customer has not confirmed they are an end user
– The customer has not confirmed they are an intermediary supplier
It applies widely to supplies classified as “construction operations” for CIS purposes, including alteration, repair, extension, demolition and installation works, and includes goods supplied as part of those services.
It’s useful to know when the DRC does not apply, namely:
– The customer is not VAT‑registered or not CIS‑registered
– The customer has formally declared they are an end user or intermediary supplier
– The supply is zero‑rated, e.g. new‑build housing
– The supply is between connected landlords and tenants or group companies, where the correct notifications are in place
Everyone agrees that DRC is a challenge. Even businesses acting in good faith continue to struggle with implementation.
Common issues include:
– Misinterpreting the rules
– Assuming the “other party” will determine the correct VAT treatment
– Missing key details such as end‑user notifications
– Incorrect invoicing that fails to flag the application of the DRC
– Suppliers knowingly charging incorrect VAT to boost short‑term cash flow
These errors cause disputes, payment delays, poor cash forecasting and, increasingly, HMRC intervention.
Over the last few years, I’ve helped contractors and subcontractors with the following: resolve disputes; set up robust DRC controls; deliver team training; and challenge unfair HMRC assessments. Here are some practical issues we see daily followed by some tips to help navigate the DRC minefield.
1. Late Payments Caused by VAT Disputes
Uncertainty around whether the DRC applies can lead to invoice disputes, and contractors may refuse to pay until the VAT treatment is resolved.
This is particularly common where:
– CIS status is unclear
– End‑user notifications are missing
– Parties have made differing assumptions about the same service
The effect on cash flow is immediate and painful.
2. HMRC Is Actively Enforcing DRC Compliance
HMRC has moved far beyond its gentle, educational approach.
[mobile-ad_sc]
We are seeing:
– More enquiries targeting errors in reverse charge accounting
– Assessments where VAT has been incorrectly charged
– Penalties and interest where systems or processes are inadequate
Worryingly, HMRC’s public webinars have not been updated to reflect this change, they still cover introductory points, while compliance teams on the ground are taking a far stricter stance.
It is essential that businesses have robust systems, accurate records and the ability to demonstrate correct decision‑making.
3. CIS Classification Confusion
A recurring issue is uncertainty over whether an activity qualifies as a “construction operation” for CIS. For example:
– Businesses assume an activity is within CIS when HMRC views it as marginal or outside scope
– Activities are mis‑classified because the terms used in the contract do not reflect the actual work
Getting CIS classification wrong often means getting the VAT wrong too.
4. Cash Flow Crunch for Subcontractors
Under the DRC, subcontractors no longer receive VAT from customers, removing a buffer many relied on for working capital. Some still feel the shock several years on.
Accurate DRC application is key to realistic cash flow forecasting.
5. Missing End‑User or Intermediary Supplier Notifications
End users and intermediary suppliers must confirm their status in writing. Without this:
– Suppliers must apply the DRC
– Customers risk incorrect VAT reporting and HMRC disputes
A simple written declaration is enough, no complex contracts required, but record‑keeping must be watertight.
6. Mixed Supplies and the 5% Rule
Where a supply contains both DRC and non‑DRC elements, the default is that the entire supply is subject to the DRC. The only exception is if the DRC element is 5% or less of the total value and both parties agree otherwise.
Documenting the rationale is essential.
7. Invoicing and Accounting Systems
Invoices must clearly state that the DRC applies and show the applicable VAT rate or amount.
System limitations often create risk, including:
– Software that cannot flag DRC services
– Staff issuing standard VAT invoices to “get things out the door”
– Inconsistent wording in templates
These errors attract HMRC attention.
8. Labour‑Only Subcontractors vs Employment Businesses
The DRC applies to labour‑only subcontractors where the subcontractor is responsible for the work and its outcome. It does not apply to employment businesses supplying staff.
The distinction depends on substance, not labels, and misclassifications are common.
Tips for Navigating the DRC:
– Check customers’ VAT and CIS status before invoicing
– Get written confirmation of end‑user or intermediary status
– Train staff on when the DRC applies
– Update contracts and terms to include DRC obligations
– Review subcontractor cash‑flow forecasts
– Maintain clear records for audit and HMRC enquiries
– Get advice early – DRC issues escalate quickly if left unresolved
In summary, the VAT Domestic Reverse Charge is now embedded in the construction sector and HMRC is clearly determined to enforce it.
While the rules aim to prevent fraud, they create real‑world challenges for compliant businesses. The best protection is clear communication, strong processes, and a willingness to seek proven professional guidance where needed.
Chair of Federation of Small Businesses Scotland, Guy Hinks
Written by Glasgow View Reporter, Liam Eunson
The Federation of Small Businesses (FSB) has today urged the Scottish Government to use January’s Scottish Budget to protect small businesses facing significant non-domestic rates rises.
Some of the stalwarts of local high streets, including independent pubs and post offices, are facing huge rates rises in April as a result of the latest revaluation of their properties. Small accommodation providers across the country have also received draft notices which would see their rates bills soar by up to 400%.
In a letter to Public Finance Minister, Ivan McKee, FSB is calling on the Scottish Government to introduce measures in its forthcoming Budget to ensure small businesses are protected from a significant tax increase on top of existing cost pressures.
Guy Hinks, FSB Scotland Chair, said:
“The prospect of dramatic increases in their business rates couldn’t come at a worse time for small businesses when economic conditions are already extremely challenging. That is why it is so important the Scottish Government uses the opportunity presented in its Budget in January to protect hard-pressed small businesses.
“Ever increasing costs, combined with turnovers that are now falling, means profitability is being squeezed out of local businesses. The last thing they need is the rates revaluation turning into another costs nightmare in April.
“Any boost those in the retail, hospitality and leisure sectors may have been hoping for during the so-called “golden quarter” in the run-up to Christmas could be wiped out by the looming increase in their rates bill come the spring.
“We are asking the Scottish Government to take sensible steps to protect many otherwise robust businesses. They have options at their disposal. Taking action now means they are more likely to be able to weather the current economic storm and come out the other side in a position to continue serving local communities and supporting local jobs.”
FSB is calling for the Scottish Government to reduce the multiplier used to calculate final rates bills. The results of the draft 2026 revaluation mean that freezing the multiplier as in previous years may no longer be enough to mitigate the extent to which rates bills will increase next year, it said.
Mr Hinks added: “Given the scale of some of the increases to rateable values we are seeing, we are concerned that even a freeze will mean the Scottish Government’s commitment to keep 100,000 businesses out of non-domestic rates altogether will be eroded even further.
“That’s why we’re also calling for the introduction of a new, reduced multiplier for those businesses in the retail, hospitality and leisure sectors, mirroring actions taken in England and Wales.”
With a significant proportion of small businesses facing increases to their rateable values, this may mean they lose the rates relief they receive through the Small Business Bonus Scheme (SBBS).
FSB is therefore calling on the Scottish Government to use January’s Budget to restore the thresholds for SBBS relief to at least the levels they were set at before they were reduced in 2023. At the absolute minimum, transitional relief for those impacted by the most significant RV increases is essential, it added.
