Conceived in 1971 to prevent perceived tax evasion by construction workers, the Construction Industry Scheme (CIS) is a UK tax deduction scheme. It involves tax being deducted at source (0%, 20%, 30%) from payments made by contractors to subcontractors for construction operations. Any tax withholding is then paid over each month to HM Revenue & Customs (HMRC) by the contractor.
There are two types of contractors:
- Mainstream – any person carrying on a business that includes construction operations, for example property developers and builders.
- Deemed – any person carrying on a business at any time where:
- its average annual spend on construction operations is more than £1 million in the three years ending with the end of the period of account before that time, for example property investment businesses
- HMRC is not satisfied that the expenditure on construction operations has been less than £1 million in each of three successive subsequent years.
In general, CIS applies to all payments made under a ‘construction contract’ – a contract relating to, or partly including, ‘construction operations’. Construction operations are legislatively defined as essentially any work in the construction, alternation, repair and demolition of buildings or structures. It also includes the installation of key building systems (such as heating, lighting), and interior and exterior decorating and cleaning under a construction contract. All construction operations carried out in the UK or its territorial waters are caught by the scheme.
What is the effect of applying CIS to contractors?
Once registered with HMRC, the contractor must file monthly CIS returns stating the total amounts paid (excluding VAT), the cost of materials and the CIS tax deducted (percentage applied to the cost of labour) for each subcontractor under a construction contract.
CIS requires the contractor to verify the subcontractor with HMRC before payment is made. There are three possible scenarios:
- the subcontractor has gross pay status (GPS) so is subject to no tax deduction
- the subcontractor is subject to a 20% deduction applied to the labour elements, which is paid to HMRC monthly
- the subcontractor is subject to a 30% deduction applied to the labour elements, which is paid to HMRC monthly.
For CIS purposes, invoices are only comprised of material and labour elements. It is the contractor’s responsibility to ensure that the materials element of the invoice is not overstated by the subcontractors.
Is the subcontractor really self-employed?
CIS does not apply to payments made to employees, since payments to employees are covered by the PAYE/NIC system. However CIS does apply to self-employed subcontractors and individuals. It is the contractor’s responsibility to ensure that the employment status of the individuals is correct and it should be reported to HMRC via the CIS monthly returns. Whether an individual is an employee is a matter of law and depends on the facts and the terms of the agreement with the contractor.
It is important for contractors to get the status right as they can be held liable for any PAYE/NIC underpaid. They should also make sure to check the status regularly to ensure nothing has changed.
CIS maintains a registered database of subcontractors – those subcontractors with a history of good compliance and a turnover above a certain threshold hold Gross Payment Status (GPS) where no tax deduction is applicable, with the remainder having deductions made by the contractor under a construction contract.
What are the contractor’s responsibilities ?
- Registering with HMRC
- Ensuring the status of any workers or sub-contractors is correct
- Verifying the identity of its sub-contractors
- Deducting tax from payments to sub-contractors (not employees subject to PAYE)
- Providing written statements to sub-contractors
- Keeping records
- Submitting monthly returns to HMRC
- Notifying HMRC of certain changes to its business.
What are the subcontractor’s responsibilities?
- Registering with HMRC to ensure tax is not deducted from payments by the contractor at 30%
- Ensuring the contractor has sufficient information to verify the sub-contractor’s status with HMRC
- If registered for gross payment, ensuring its continuing compliance with the requirements for such registration
- Keeping records
- Notifying HMRC of certain changes to its business.
Are there any exceptions to CIS?
There are many exceptions to CIS which include:
- payments of a reverse premium (ie. landlord to tenant for fit out costs)
- payments by a charity, public sector body or certain schools (this does not apply to their trading subsidiaries)
- deemed contractor payments are exempt if expenditure relates to offices, warehouses, nursing homes and any other facilities used for the business ie. for self-build purposes (under Regulation 22, SI 2005 No 2045).
What about penalties and typical CIS problem areas?
The contractor must file monthly returns with HMRC from the date that they have registered. If a contractor fails to submit the monthly CIS return on time, penalties of £100 are levied even if the return is one day late. If the return is two months late, the penalty is £200. If six or 12 months late, a penalty of £300 or 5% of the CIS deductions (whichever is higher) is applied at each interval. If the return is more than 12 months late, an additional penalty of £3,000 or 100% of the CIS deductions (whichever is higher) may be levied.
Appealing penalties with HMRC is most often not a straightforward process and, unless there are reasonably extenuating circumstances, an appeal is unlikely to be successful as evidenced by the many cases before the First Tier Tribunal. Therefore care should be taken by contractors.
In addition, we have seen a number of recent enquiries by HMRC into non-compliance with CIS generally but also specifically:
- how materials have been reported and the split out on invoices raised
- employment status of workers
- if the total contract has been included, rather than just the ‘construction’ part
- have the rules been applied to all construction payments – for instance:
- a business involved with installing entry phones is not within the remit of CIS, but a company providing door access systems is
- the treatment of project management is frequently considered to be outside the scope of CIS when actually it is caught
- stained glass windows are included with CIS but sculptures are not.
What future changes might we expect to CIS?
Since taking form in 1971, CIS has been modified with a major reforms in 1999 and April 2007. There are further reforms and plans afoot to tackle worker status issues in the industry, which contractors and subcontractors should be mindful of:
- 6 April 2019 – extension of existing security deposit legislation to include corporation tax and the CIS
- 1 October 2019 – address the fraud provision of labour, by introducing a domestic ‘reverse charge’ for the construction sector whereby the customer in the transaction is responsible for accounting the VAT
- compliance for those obtaining and holding GPS will increase.
- Be aware of your obligations as contractor and/or subcontractor under CIS:
- register with HMRC and file monthly returns on time
- only construction operations are caught – consider whether an exemption applies
- subcontractors must be self-employed, and their status periodically reviewed
- ensure CIS is applied to all the necessary payments; often invoices in other parts of the business can slip through
- Have a process in place to identify construction contracts and report all subcontractors as applicable on the CIS returns
- Have an adequate process in place to capture all that is needed
- Keep updated with future and ongoing changes to CIS
- Seek specialist advice where necessary to ensure compliance with the latest CIS requirements