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Domestic Reverse Charge for Construction; 10 practical steps to mitigate the impact on working capital

22 November 2019

Updated 10 June 2020


HMRC has announced a further delay to the Domestic Reverse VAT Charge for Building and Construction Services (DRC) “To help these businesses overcome the effects that the coronavirus pandemic” - it will not now come into force until 1 March 2021.

The delay in the introduction of the DRC will provide affected businesses with additional time to prepare for the impact on systems and cash flow.  However, the revised timing of the introduction to 1 March 2021 is also likely to have a potentially unforeseen consequence.  Construction businesses that deferred VAT payments that were due between 20 March 2020 and 30 June 2020 as part of the UK Government’s COVID-19 measures will be required to make these payments on or before 31 March 2021, meaning that cash flow in March 2021 is likely to be a major issue in the construction sector and businesses should be focusing on the issue at the earliest opportunity.

The announcement also introduced the requirement for End Users to issue a written confirmation to their suppliers to confirm their status.

HMRC has already published legislation and guidance on this new regime, which will require the recipient rather than the supplier to account for the VAT due on certain construction services.

One of the biggest questions surrounding the change is the impact for companies on their working capital. Whilst businesses shouldn’t be relying on HMRC monies to fund working capital requirements, in reality they may be doing so. The new legislation means that, for a time, your business may have up to 20% less working capital for up to 90 days when the DRC is introduced.

We have prepared a list of 10 practical steps to prepare your business and ensure that you mitigate or avoid any working capital issues caused by the introduction of the DRC.

Download 10 practical steps for ‘Optimising Your Working Capital’

 

Construction businesses typically operate on low margins. There is also the perception that payment practices within the sector are poor and that the culture towards this needs to change. There are other regulatory requirements and initiatives which have been introduced to address payment performance which will also have a potential impact on working capital:

  • Duty to Report on Payment Practices – introduced to create transparency of payment practices and performance for large UK companies
  • Cabinet Office announcement that as of 1st September 2019, companies that wish to bid for public contracts in excess of £5m should be able to demonstrate the ability to pay 95% of their suppliers within 60 days
  • Prompt Payment Code – voluntary code for signatories to demonstrate commitment to fair payment practices within the UK
  • Construction Supply Chain Payment Charter – introduced to address specific challenges within the sector

The ongoing government focus on payment fairness, companies cannot simply look to push out supplier payments to cushion some of the cash flow impact of the DRC. The introduction of IR35 in April 2020 should also be considered as it has a potential to impact cash outflows.

Supply chains may become more fragile and interdependencies will have to be managed well. Whilst it is hoped that the ‘end user’ will try to mitigate some of the impact in order to retain a healthy supply chain, there is an opportunity for affected companies to take control. Whilst the Receivables position may be impacted initially, this will also be true for payments to your suppliers and sub-contractors. It is therefore critical to understand the impact of DRC on your business. It is a chance for companies to proactively assess their end-to-end working capital management and identify opportunities to optimise processes to provide a source of competitive advantage.

A full explanation of and the latest news on the Domestic Reverse Charge for Construction is available here.