SECTOR INSIGHT
Solving the DRC and IR35 Conundrum
» RECENT CHANGES IN LEGISLATION have added to the complexity of running an installer business . Ben Dyer of Powered Now looks at how the new VAT rule called DRC ( Domestic Reverse Charge ) impacts business and how the new rules on employees and subcontracting called IR 35 does as well .
Who isn ’ t impacted Let ’ s start out by saying who won ’ t be impacted by these recent changes . That way you can save several minutes of your life that you might have spent reading this article !
If you never subcontract for anyone , never use subcontractors and you are always working for end customers , there is nothing to worry about . Neither of these changes will have an impact . Lucky you .
If that doesn ’ t apply , you need to get up to speed with the new rules .
The principle of DRC DRC came into effect from 1st March 2021 . It is so called because it applies the “ reverse charge ” VAT principle used in selling to the EU ( when we were part of the EU ) to some business-to-business transactions in the UK .
DRC is designed to prevent a certain type of VAT fraud .
Suppose one trade business does work for another and both are VAT registered . The supplier ( subcontractor ) charges VAT and the customer receiving the service pays the VAT . The supplier then pays their VAT to HMRC and the customer claims the VAT back . The net position is everyone is square .
When there is no subcontracting or either party is not VAT registered , DRC doesn ’ t apply .
Here ’ s how the fraud can work . If the supplier ( subcontractor ) fails to pay the VAT then goes bust , HMRC is out of pocket but the supplier has had the benefit of the VAT . If they did this a number of times with new businesses , it can be quite lucrative . In the meantime , the customer doesn ’ t care because they aren ’ t out of pocket as they reclaimed the VAT .
The same happens if the supplier claims that they are VAT registered but aren ’ t . The customer again doesn ’ t need to check because they don ’ t lose out . The supplier ( subcontractor ) can either discount their prices to compete unfairly or pocket the VAT or a combination of the two . And it ’ s hard for HMRC to track this down .
Under DRC , there are no repayments from HMRC , so the fraud doesn ’ t work .
When DRC applies
DRC applies when the following is true :
• The transaction falls within the scope of CIS
• Both parties are or claim to be VAT registered
• None of the exceptions apply When DRC applies , it applies to the entire amount of the transaction between the parties , unlike CIS . So , DRC applies to both labour and the materials .
The exceptions , when DRC won ’ t apply , are :
• The supply is Zero or Exempt from VAT
• The supplier ( subcontractor ) is an employment business
• The customer is an end user of the supply
• Materials are 5 % or less of the supply
How DRC is handled There are three elements to how DRC is handled :
• VAT is not charged
• A message is displayed on the sales invoice relating to DRC such as “ Domestic Reverse Charge : Customer to account for VAT to HMRC ” but the rate that would have applied if DRC didn ’ t apply should be stated i . e . standard or reduced rate
• The MTD reporting to HMRC is slightly different . The supplier reports the VAT amount that would have been due in both boxes 1 and 4 and the amount excluding Vat in box 7 . The customer reports the amount excluding Vat in box 6 .
The principle of IR35 and the recent change
IR35 is designed to make workers who could reasonably be regarded as employees to actually become officially employed by their clients .
The way workers avoid being employees is by creating an intermediary ( usually a limited liability company known as a PSC or personal service company ) which they own or part own and which charges the client . This intermediary then pays the worker with a mix of salary and dividends .
The motivations for people to take this approach are threefold :
• Workers make more money by working through an intermediary . They do this by paying some of their compensation as dividends which are not subject to national insurance and which also reduce income tax a little
• The client can save employer ’ s national insurance on the salaries being taken
• The client avoids the restrictions and other costs associated with employment
HMRC ’ s IR35 initiative just addresses the loss of tax and NI .
When IR35 applies , workers become “ deemed employees ” and their tax is handled as though they are actual
58
MAY / JUN 2021
locksmithjournal . co . uk Issue Takeover
Magazine Sponsor