How the Reverse Charge Hits Subcontractor Cash Flow

The cash you used to hold has gone

For most of its history, VAT gave a subcontractor a quiet cash-flow benefit. You invoiced a job, added 20% VAT on top, and the customer paid you the full amount including that VAT. The tax was never yours to keep, but you held it until your VAT return was due, sometimes for two or three months. On a steady book of work that float sat in your account the whole time, smoothing out the gaps between paying wages and getting paid.

The VAT domestic reverse charge, in force since 1 March 2021, removes that float for supplies between VAT-registered construction businesses. You no longer charge VAT on the affected work. The customer accounts for it instead. The money you used to receive and hold now never reaches you at all, and for a labour-heavy subcontractor on tight margins, losing that buffer is the part that actually bites. This guide builds on our overview of the VAT reverse charge for construction and focuses on the cash-flow side.

What changed on your invoice

Under the reverse charge you issue an invoice that shows the net value of the work but charges no VAT. You must still make the VAT position clear. HMRC requires the invoice to show how much VAT is due under the reverse charge, or where your software cannot show the amount, the rate of VAT, but that figure is never added to the total the customer pays you. The invoice also needs wording that flags the reverse charge applies, such as "reverse charge: customer to pay the VAT to HMRC" or a reference to Section 55A of the VAT Act 1994.

The practical effect is simple. On a £10,000 labour job that used to be invoiced at £12,000 including £2,000 VAT, you now invoice £10,000 and receive £10,000. The £2,000 you would once have banked and held until your return is gone from your cash position entirely. Multiply that across a month of invoices and the working-capital hole is real, even though you never owed that money in the first place.

How it shows up on your VAT return

As the subcontractor making a reverse-charge supply, you report the net sale in Box 6 (total value of sales) but you do not put any output VAT in Box 1, because you have not charged any. The customer is the one who adds the VAT to their output tax and, where they can recover it, claims it back as input tax in the same return. You still recover the VAT on your own costs, materials, fuel, plant hire, in the normal way, which is where the cash-flow problem can flip the other direction.

If you buy materials with VAT on them but your sales carry no output VAT to set that against, your return can move from regularly paying HMRC to regularly reclaiming from HMRC. Many subcontractors who switched to the reverse charge found themselves in a repayment position for the first time. That is not a loss, the money comes back, but it arrives after you submit the return rather than being netted off as you go, so the timing still works against you.

Practical ways to manage the gap

The first move is to stop budgeting as though the VAT element is still coming in. If your accounting habits, or your own mental arithmetic, still treat the gross figure as available cash, the reverse charge will catch you out at the worst moment. Reforecast on net receipts only.

Where your return now runs to a repayment, consider switching from quarterly to monthly VAT returns. HMRC allows monthly returns specifically because they suit businesses in a regular repayment position, and getting your input VAT back twelve times a year instead of four pulls that cash forward. It is a standard, legitimate change and one worth discussing alongside how the reverse charge interacts with your CIS returns, since the two regimes overlap on the same payments.

• Move to monthly VAT returns if you are now in a repayment position, so input VAT comes back faster.
• Forecast cash on net invoice values, never the old VAT-inclusive figure.
• Keep input VAT records tight so repayments are not delayed by queries.
• Check whether your customer is genuinely the end user, because an end-user supply stays under normal VAT and the float returns.

When the reverse charge does not apply

The reverse charge only bites on supplies that fall inside the Construction Industry Scheme between two VAT-registered businesses where the customer is not the end user. If your customer is the end user, broadly a VAT and CIS-registered business that does not make an onward supply of your construction services, then normal VAT applies and you charge it as before. The customer has to tell you in writing that they are an end user, by post, email or in the contract, so do not assume it.

There is also a 5% disregard for mixed supplies. Where the reverse-charge element is 5% or less of the value of a larger supply, and both sides agree at the outset, the whole supply can be treated under normal rules. These edge cases decide whether you get the VAT float back on a given contract, so they are worth getting right rather than defaulting to the reverse charge on everything. The same care applies to how the deduction interacts with CIS tax deductions on the labour element of your invoices.

The official rules are set out in HMRC guidance on the VAT domestic reverse charge for building and construction services, and the professional position is summarised in the ICAEW overview of VAT reverse charge issues. If you are a subcontractor feeling the cash-flow squeeze since the change, send us the details through the form on this page and we will look at your return frequency and end-user position.