How Does VAT Work in the Construction Industry Scheme

Introduction

The Construction Industry Scheme (CIS) requires contractors to deduct tax at source from payments made to subcontractors. However, VAT sits outside the CIS tax deductions and must be accounted for separately.

To prevent VAT fraud in the construction sector, HMRC introduced the domestic reverse charge for building and construction services in March 2021. This rule changes how VAT is reported and paid between contractors and subcontractors working on most construction projects.

Understanding how VAT and CIS interact is essential for keeping your tax records correct and avoiding HMRC penalties.

The Construction Industry Scheme explained

Under CIS, contractors deduct money from subcontractor payments and pass it to HMRC. These deductions count as advance payments towards the subcontractor’s tax and National Insurance.

CIS covers most construction work carried out in the UK, including building, repairs, installations, and demolition. Both contractors and subcontractors must register with HMRC if they operate within the scheme.

While CIS controls income tax deductions, VAT is still applied according to standard VAT rules or the domestic reverse charge, depending on the type of work and who the customer is.

The domestic reverse charge for VAT

The domestic reverse charge applies to most VAT-registered construction services supplied between VAT-registered businesses in the UK. It shifts the responsibility for accounting for VAT from the supplier (the subcontractor) to the customer (the contractor).

This means that subcontractors no longer charge VAT on certain construction invoices. Instead, the contractor reports both the output and input VAT on their own VAT return.

The domestic reverse charge applies to supplies that are:

Reported under CIS.

Made between VAT-registered contractors and subcontractors.

Not zero-rated or exempt.

For standard or reduced-rated construction services.

If any of these conditions are not met, the normal VAT rules apply.

Example of the reverse charge in action

A VAT-registered subcontractor provides plastering services worth £5,000 to a VAT-registered contractor. Under the reverse charge, the subcontractor issues an invoice showing the amount of VAT due (£1,000 at 20 percent) but does not add it to the total.

The invoice states: “Reverse charge: customer to account for VAT to HMRC.”

The contractor includes £1,000 as output VAT (sales VAT) and the same £1,000 as input VAT (purchase VAT) on their VAT return.

The subcontractor records the sale as net of VAT and does not pay any VAT to HMRC.

No actual VAT changes hands between the two businesses.

When the reverse charge does not apply

Normal VAT rules apply if:

The customer is not VAT registered.

The work is zero-rated (for example, new residential housing).

The work is outside the scope of CIS.

The customer is an end user or an intermediary supplier.

End users and intermediary suppliers

An end user is the final customer who will use the building or service, such as a property developer, landlord, or business commissioning work for their own premises.

If your customer is an end user, they must notify you in writing that they are the end user, and you should charge VAT as normal. The domestic reverse charge does not apply.

Similarly, if your customer is an intermediary supplier (for example, a company connected to the end user that buys construction services for internal use), the normal VAT rules also apply.

Example

You are hired by a commercial property owner (the end user) to carry out electrical work. They confirm in writing that they are the end user. You charge VAT in the usual way, adding 20 percent to your invoice and accounting for it in your VAT return.

Invoicing under the reverse charge

If you are a subcontractor working under CIS and the reverse charge applies, your invoice must include:

The amount payable for the work (excluding VAT).

The VAT rate that applies (for example, 20 percent or 5 percent).

A statement such as “Reverse charge: customer to account for VAT to HMRC.”

Do not include the VAT amount in the total invoice figure. You must also show your VAT number and CIS registration details if required.

Contractors should check that subcontractors’ invoices are correctly worded before processing payments.

How to report VAT under CIS

Both contractors and subcontractors report VAT through their regular VAT returns. The difference lies in who accounts for the VAT:

Subcontractors issue invoices under the reverse charge without adding VAT. They record the net amount as a sale.

Contractors record both output VAT and input VAT on their VAT return. This cancels out, so there is no net VAT to pay or reclaim unless they make exempt or partially exempt supplies.

All other non-reverse charge transactions, such as supplies to end users, follow the usual VAT accounting process.

Interaction between VAT and CIS deductions

While VAT is not included in CIS deductions, it still affects cash flow. Under CIS:

Contractors deduct tax from subcontractor payments before VAT is applied.

VAT is calculated on the full invoice value before CIS deductions.

This means the contractor pays the subcontractor the invoice amount minus CIS tax but without any VAT element if the reverse charge applies.

Example

A subcontractor invoices £10,000 for work under CIS. The contractor deducts 20 percent CIS tax (£2,000) and pays £8,000.
If the domestic reverse charge applies, no VAT is added, and the subcontractor records a £10,000 sale on their books.

Record keeping requirements

Both contractors and subcontractors must keep detailed records to show how VAT and CIS deductions were calculated. These include:

Contracts and correspondence confirming the type of work and customer status.

Copies of invoices and payment records.

Proof of CIS registration and deductions.

Evidence of VAT status and reverse charge application.

Records should be kept for at least six years to comply with HMRC rules.

Common mistakes to avoid

Charging VAT when the reverse charge should apply.

Failing to confirm whether the customer is an end user.

Forgetting to include a reverse charge statement on invoices.

Including VAT in CIS deductions (VAT is excluded from CIS calculations).

Mixing zero-rated and standard-rated work without separating them on invoices.

Checking customer details and reviewing each contract carefully will help ensure compliance.

Example scenario

Tom is a subcontractor registered for VAT and CIS. He provides plumbing services to a VAT-registered contractor working on a commercial office project.

Because both parties are VAT registered and the work falls under CIS, the domestic reverse charge applies. Tom issues an invoice for £5,000 with a note stating: “Reverse charge: customer to account for VAT to HMRC.”

The contractor reports both £1,000 VAT output and £1,000 VAT input on their VAT return. Tom records the £5,000 sale but does not include VAT in his return.

No VAT is exchanged, but both parties remain compliant.

Conclusion

VAT in the Construction Industry Scheme operates differently from standard VAT rules because of the domestic reverse charge. The subcontractor does not charge VAT on most construction services to a VAT-registered contractor. Instead, the contractor accounts for VAT on their own VAT return.

If your customer is an end user, normal VAT rules apply, and you must charge VAT in the usual way. Keeping accurate records, issuing correctly worded invoices, and confirming each customer’s VAT status will ensure you meet HMRC requirements.

Understanding how VAT and CIS interact will help you stay compliant, avoid costly mistakes, and manage your cash flow effectively within the construction industry.