How FreeAgent handles the domestic VAT reverse charge for subcontractors

This article explains how FreeAgent handles the domestic VAT reverse charge for subcontractors under the Construction Industry Scheme (CIS).

The domestic VAT reverse charge came into effect on 1st March 2021. VAT-registered subcontractors should follow these instructions when explaining CIS payments or creating CIS invoices for contractors where the domestic VAT reverse charge should be applied.

If you're also a contractor, find out how FreeAgent handles the domestic VAT reverse charge for contractors.

1. Enable non-standard VAT rates

To apply the domestic VAT reverse charge to a bank transaction or CIS invoice, you must first enable non-standard VAT rates in your FreeAgent settings. 

To do this, select ‘Settings’ from the drop-down menu in the top-right corner and then select ‘VAT Registration’ from the ‘Accounting, Tax & VAT’ section.

On the ‘UK VAT Registration’ page, scroll down to the ‘VAT settings’ section and select ‘Yes’ in response to the question ‘Do you need to use VAT rates other than standard UK ones?’. 

Select ‘Save Changes’ at the bottom of the screen to complete the process.

2. Set up CIS

Next, you must enable the CIS feature for subcontractors in your FreeAgent account before following the steps outlined below.

3. Record CIS income

To record your CIS income, you can either explain the payments from the contractor in the Banking area or create reverse charge invoices.

Explain the payment from the contractor as CIS income

If you're not creating invoices, you'll need to explain the payment from the contractor as CIS income once it's imported into FreeAgent.

If you need to apply the domestic VAT reverse charge to a payment from a contractor, click on the relevant transaction, select 'Adjustments' and choose 'More options' from the drop-down menu.

If you don't need to apply the domestic VAT reverse charge to a payment from a contractor, please read how to explain bank transactions as CIS income instead.

If the payment relates to labour only, select 'Sales' from the 'Type' drop-down menu, ‘Reverse Charge’ from the ‘VAT options’ and ‘Out of Scope’ from the ‘VAT’ drop-down menu.

Choose the relevant CIS income rate from the 'Category' drop-down menu and select ‘Create New Explanation’ at the bottom of the screen to complete the process.

If the payment relates to labour and materials, you'll need to split the transaction between the labour amount (using the 'CIS Income' category) and the materials amount (using the 'Sales' or a custom category). Read more about how to explain bank transactions as CIS income.

Create reverse charge invoices

If you need to apply the domestic VAT reverse charge to a CIS invoice, begin by following the steps to create the invoice, then open the ‘More options’ section and choose ‘Reverse Charge’ from the ‘VAT options’. You'll only see this option if you have enabled non-standard VAT rates in your FreeAgent settings. 

Adding text to the invoice

Choosing the ‘Reverse Charge’ option will add the additional text ‘Reverse charge supplies’ to the invoice automatically. You can add to this text if you wish. 

To comply with HMRC’s guidelines for creating reverse charge invoices you also need to include the rate or amount of VAT you would have charged on the sale if the reverse charge had not been applied:

• If this is a one-off sale, you can either edit the relevant invoice line item to include this information or add an additional line item, choosing ‘Comment’ as the unit type and including the VAT amount or rate in the description.
• If this is a sale that you will make regularly, we recommend that you save the information as a price list item when you create the invoice. This will allow you to add the information to other invoices quickly in the future. Include the VAT rate or amount in the price list item description, along with the relevant additional wording specified by HMRC, such as “customer to pay the VAT to HMRC”.

The image below shows how this information will be displayed on an invoice. Please note that the VAT rate appears as text and does not affect the amount that the customer is charged. When you choose the value for the invoice line item, this should be the amount excluding VAT, since it is your customer, rather than you, who will be responsible for adding this VAT to their return and paying it.

The effect in your VAT return

FreeAgent will automatically include the value of these invoices in box 6 of your VAT return. You can adjust this figure if you need to. No entries will be added to boxes 1 or 4 as per HMRC’s guidelines.