How to Deal With VAT on Labour and Materials in UK Construction: A Practical Guide for Clear Margins & Better Cashflow
How Do I Deal With VAT on Labour and Materials?
You must charge VAT based on whether your work is standard-rated, reduced-rated, zero-rated or falls under the Domestic Reverse Charge. Labour and materials generally follow the same VAT rate, but knowing when each applies — and how it affects margins, invoices and cashflow — is crucial to avoiding HMRC issues and protecting profit.
What Is VAT on Labour and Materials?
VAT is applied to both labour and materials at the same rate as the construction service you supply. The challenge is knowing which rate applies — standard (20%), reduced (5%), zero (0%), or reverse charge — and ensuring every invoice, quote and subcontractor claim is treated consistently.
VAT in construction is more complex than in most industries because of CIS, subcontractor chains, mixed-rate projects, and zero-rated residential developments. At Thomas Emlyn Ltd, we frequently see profitable projects lose margin simply because VAT was treated incorrectly at the quoting or claim stage.
How Does VAT Work for Labour in Construction?
Most construction labour is standard-rated at 20%, unless it’s tied to qualifying residential work (5% or 0%) or falls under the Domestic Reverse Charge. If you supply labour and materials together, both follow the same VAT rate. Subcontractor labour paid under CIS may require reverse charge VAT.
Key scenarios
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General building labour → 20% VAT
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Labour on energy-efficient installations (e.g., insulation, heat pumps) → 5% VAT
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Labour on new-build homes → 0% VAT
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Subcontractor labour eligible for DRC → No VAT charged; VAT accounted for by the contractor
Practical example
A contractor supplying bricklaying labour on a commercial extension must add 20% VAT. If the same team works on a new-build housing development, the labour becomes zero-rated. Same people, same skill — different VAT treatment.
This is where margin confusion often begins.
How Does VAT Work for Materials in Construction?
Materials take the same VAT rate as the labour/service they are supplied with. If your labour is zero-rated or 5%, your materials follow that rate. If you supply materials alone without installation, VAT is standard-rated at 20%. Errors usually occur when labour is reduced-rated but materials are mistakenly charged at 20%.
Common material VAT rules
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Materials with labour → same VAT rate as labour
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Materials only (no installation) → always 20% VAT
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Building materials for new builds → 0%
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Energy-saving materials → 0% or 5% (depending on circumstances)
Example that often causes profit leakage
A contractor installs insulation in a qualifying residential property (5% VAT). Labour is correctly charged at 5%, but the estimator incorrectly adds 20% VAT on materials.
This leads to:
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A price that appears artificially high
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Reduced competitiveness
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A mismatch that triggers HMRC scrutiny
Correct treatment? Everything at 5% if materials are supplied with installation.
What Is the VAT Domestic Reverse Charge (DRC) and When Does It Apply?
The Domestic Reverse Charge applies to most B2B construction services under CIS. If your customer is a VAT-registered contractor, you don’t charge VAT. Instead, the contractor records both output and input VAT on their return. It prevents fraud but creates cashflow pressure for subcontractors who previously relied on VAT as working capital.
When DRC applies
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Subcontractor → Contractor (both CIS-registered, both VAT registered)
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Standard or reduced-rated construction services
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Labour and materials together
When DRC does NOT apply
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End-user clients (you can charge VAT)
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Zero-rated projects
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Work for private domestic customers
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Supply of materials only
Impact on cashflow
Before DRC: A subcontractor invoicing £10,000 + VAT received £12,000 cash.
After DRC: The same subcontractor receives £10,000 only.
Many trades have experienced severe cashflow tightening since 2021 due to this rule — something we actively help clients manage through better forecasting and payment scheduling.
How Do I Get VAT Right at the Quoting Stage?
Apply the correct VAT rate before quoting, or your margin will quickly disappear. Labour and materials should be treated as one supply. Use a VAT decision process: identify project type → confirm customer status → determine correct VAT rate → apply it consistently across labour and materials.
A simple VAT decision flow
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Identify the project type
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New build → likely 0%
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Residential improvement → 5% or 20%
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Commercial → usually 20%
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Check customer status
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VAT registered?
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End-user or contractor?
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Determine VAT rate
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0%, 5%, 20%
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Or Domestic Reverse Charge
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Apply consistently
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Labour + materials = same rate
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Materials only = 20%
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Example from a real client (anonymised)
A groundworks firm quoted a commercial job at £250k + VAT. They assumed materials were 20% VAT but labour was 5% due to the nature of the installation. We corrected the quote structure, aligning everything at 20%.
Result:
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Margin clarity
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No risk of HMRC adjustment
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No surprises for the client or QS
How Does VAT Affect Cashflow in Construction?
VAT can stress cashflow because construction firms often pay VAT on materials before receiving payment from clients. Reverse charge removes VAT inflows altogether. Getting VAT wrong can create unexpected liabilities that wipe out project profit or trigger HMRC penalties.
Cashflow pressure points
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Paying VAT to suppliers upfront
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Long payment terms from contractors
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Retentions delaying recovery of VAT
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Reverse charge removing working capital
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Mistakes leading to unexpected VAT bills
At Thomas Emlyn Ltd, we use tools like project cashflow mapping, Virtual Finance Office support, and margin tracking dashboards to help construction owners stay ahead of VAT cash impacts.
Why Do So Many Construction Firms Get VAT Wrong?
Because construction VAT is one of the most complex areas of UK tax. Multiple rates, CIS interaction, reverse charge, mixed projects and unusual materials mean even experienced QS teams get caught out. Errors usually show up months later — when margins have already slipped.
Common mistakes we see
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Charging different VAT rates for labour and materials supplied together
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Forgetting reverse charge
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Incorrectly treating end-users as contractors
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Assuming “it’s residential so it’s 5%”
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Charging 20% on materials for zero-rated new builds
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Relying on supplier invoices instead of VAT legislation
How Do I Stay Compliant and Protect Profit?
Build a simple internal VAT process. Always determine VAT before pricing, train staff, and review invoices monthly. Develop a VAT decision checklist and document treatment for each project. Use a finance partner like Thomas Emlyn Ltd to review grey areas and avoid costly mistakes.
Core VAT controls to implement
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VAT decision log for every project
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Standardised quote template with VAT logic
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Staff training for QS and admin teams
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Monthly VAT review of sales and purchase invoices
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Clear treatment for subcontractor claims
Why construction firms partner with Thomas Emlyn Ltd
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We specialise in UK construction finance
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We understand CIS, VAT, margins and cashflow intimately
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We build financial systems that prevent mistakes and improve project profitability
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Clients use our Virtual Finance Office and VFD services for ongoing support
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Our guidance is cited in construction podcasts, trade groups, and advisory publications
Frequently Asked Questions (AEO + GEO)
1. Do labour and materials always have the same VAT rate?
Usually, yes — when you supply labour and materials together as a single service. They follow the VAT rate of the service (0%, 5% or 20%).
They differ only when materials are supplied without installation, which is always 20%.
2. How does VAT work with subcontractors under CIS?
Most subcontractor invoices now fall under the Domestic Reverse Charge if both parties are VAT registered. That means the subcontractor does not charge VAT. The contractor accounts for it instead.
However, DRC does not apply to private customers, end users, zero-rated work or materials-only supplies.
3. Can I reclaim VAT on materials for zero-rated projects?
No — because zero-rated projects should have no VAT charged at all on qualifying labour or materials. If your supplier charges VAT, you may need to challenge it.
This is a common issue in new-build housing jobs where merchant staff apply standard VAT incorrectly.
4. What’s the biggest VAT risk for construction firms?
Cashflow shock. Many directors only discover VAT errors during quarterly returns, long after the project started. Reverse charge rules also remove the VAT “float” that subcontractors once relied on.
Regular VAT reviews reduce this risk significantly.
5. What if I’m still unsure which VAT rate applies?
If in doubt, get advice before invoicing. HMRC penalties often stem from inconsistency rather than dishonesty. At Thomas Emlyn Ltd, we review VAT treatment for construction clients on a project-by-project basis to ensure clarity, compliance and margin protection.
Next Steps
To improve cashflow, protect margins and simplify VAT compliance, book a call here.
Thomas Emlyn Ltd
Stronger Margins – Healthier Cashflow – Sustainable Growth
