The Construction Industry Scheme (CIS) is designed to decrease perceived undeclared payments in the construction sector. The CIS attempts to tackle this by requiring ‘contractors’ to deduct tax from payments made to ‘sub-contractors’ and pass it to HM Revenue and Customs (HMRC).
How the CIS is changing in 2017
Prior to April 2017, contractors could verify whether sub-contractors were registered and whether they could be paid gross online or by phone. From the 6th of April 2017 sub-contractors will have to be registered online. The system is likely to be more regimented and harder to navigate.
How the CIS works
The CIS requires contractors to register for the scheme and to withhold tax before payments are made to sub-contractors under contracts relating to construction operations. Such contracts include contracts with a construction element as well as pre-construction contracts. The amount of tax withheld depends on the registration status of the sub-contractor:
- if they are unregistered, 30% must be withheld;
- if they are registered, 20% must be withheld; and
- if they meet certain criteria and register for gross payments, 0% must be withheld.
The contractor must then pass to the HMRC the amounts withheld. The contractor must first calculate the amount of the contract payment minus any VAT. He may then make further deductions for:
- equipment which is now unusable (‘consumable stores’);
- fuel used (except for travelling);
- equipment hired for this job (‘plant hire’); and
- manufacturing or prefabricating materials.
The contractor should request evidence from the sub-contractor as to the cost of the materials but if not provided, the contractor must make a fair estimate. If HMRC consider this estimate excessive, it may seek to recover any over-deduction from the contractor.
Under the CIS you are deemed a contractor if you are a business that:
- pays sub-contractors for construction work; or
- doesn’t do construction work but spends an average of more than £1 million per year on construction in any three year period.
This is a broad definition and catches many companies that may not think that they are contractors. It may include employers/developers, local authorities and pension fund investors.
Under the CIS you are deemed a sub-contractor if you work for a contractor and you are either:
- the owner of a limited company; or
- a partner in a partnership or trust.
This is likely to catch parties not usually referred to as sub-contractors in construction contracts. For instance, it may consider a building contractor employed by a developer as a sub-contractor (as that developer may be deemed a contractor for CIS purposes).
For cash-flow purposes, most sub-contractors would be well-advised to register for gross payments to retain the full amount paid to them (and pay the necessary tax themselves). However, to register for gross payments a sub-contractor must:
- be carrying out (or providing labour for) construction work in the UK;
- run its business through a bank account; and
- have filed all tax returns on time and made all tax payments in full and on time.
Further, the sub-contractor’s turnover for the past twelve months (ignoring VAT and the cost of materials) must be at least:
- £30,000, for a sole trader;
- £30,000, for each partner (or £100,000 for the whole partnership); or
- £30,000, for each director (or £100,000 for the whole company).
This makes it challenging for smaller sub-contractors to register for gross payments.
The CIS takes a broad approach as to what constitutes construction operations; they include, but are not limited to:
- preparing the site, e.g. laying foundations, providing access;
- demolition and dismantling;
- building work;
- alterations, repairs and decorating;
- installing systems for heating, lighting, power, water and ventilation;
- cleaning the inside of buildings after construction work.
The CIS covers the majority of construction work but does contain exemptions such as:
- architecture and surveying;
- scaffolding hire (without labour);
- making and delivering construction materials;
- construction site support roles, e.g. site facilities.
Potential problems with the definitions:
The definitions used by the CIS are clearly designed to catch a wide range of transactions and this can cause confusion where parties that would not usually be considered contractors and sub-contractors fall within the CIS definition as a deemed contractor or sub-contractor. The effect of this is that payments agreed between those parties may be subject to CIS deductions, potentially causing cash-flow problems for deemed sub-contractors.
Deemed contractors must also be careful to ensure they follow the CIS rules by registering with the scheme, registering the sub-contractors they are making payments to and properly withholding tax where appropriate. Due to the broad nature of the scheme if there is any doubt over whether the scheme applies any deemed contractor should seek advice to ensure they will not be liable for any fines or tax penalties for non-compliance.