Construction Industry Scheme Challenges – Are You Compliant? | Nick Bustin and Dinesh PancholiApr 25, 2022
The construction industry is traditionally regarded as having serious compliance issues. The changes introduced from 6 April 2021 suggest that HMRC remain focused on their compliance approach regarding the construction industry arena.
Additionally, the government announced in the recent Spring Statement that it will invest £161 million in additional staff resource over the next five years to increase HMRC compliance and debt management, with more than £3 billion expected to be raised.
It is the contractors’ responsibility to operate the Construction Industry Scheme (CIS) correctly, yet errors are frequent, either intentionally or otherwise. This can prove costly, especially if a subcontractor does not have gross payment status (i.e., the invoice is paid gross without any CIS tax deducted), as the contractor is liable for the additional tax due, including any interest and penalties that may be levied by HMRC.
In this article, we consider why CIS was introduced, how it has evolved over the years, recent changes and common mistakes contractors make when operating or not operating CIS.
Introduction to CIS
Historically, self-employed workers were paid gross/cash in hand and it was left up to the worker to register with HMRC. False names were routinely given to contractors requiring a signature for the cash being paid out. The CIS was introduced in 1971 to tackle this compliance problem and has undergone various changes with the current scheme being introduced in 2007. This introduced a change from a certificate-based scheme to:
• A requirement for contractors to verify subcontractors with HMRC either by telephone or, later, online;
• The strengthening of the requirement for contractors to show that employment status had been considered prior to operating CIS; and
• The introduction of three classes of subcontractor: those with Gross Payment Status (no CIS tax deduction), verified (20% deduction) and unverified (30% deduction) subcontractors.
There have been some further strengthening of the CIS rules applicable from 6 April 2021 and 2022 respectively, which we explain in more detail below.
Common mistakes made when operating CIS
The scope of CIS
Only construction operations fall under CIS and although it is easy to identify these in most cases, there are exceptions such as professional services (surveyors and architects), carpet fitting and delivering materials. To illustrate the difficulty, the fitting of carpets, linoleum, vinyl sheeting and other forms of floor covering is not considered a construction operation when carried out in isolation, that is, when done in a situation that does not also involve construction work. However, the fitting of all forms of floor covering included in the specification of a building undergoing construction, alteration or repair is caught by CIS, the exception is carpeting. But even carpet fitting can fall within CIS if it is part of a mixed contract, for example, the subcontractor is required to fit laminate flooring and fit carpeting under a single contract. This means that it is imperative when considering if the work being undertaken falls within CIS that the contract for the work commissioned is reviewed. This is always the starting point when HMRC undertake a CIS compliance review. This means reviewing the contract and not the payment in the first instance. A mixed contract is a contract that includes some work that falls within CIS and some that does not. In this instance, all payments made under that contract are brought within CIS.
Failing to register as a contractor or subcontractor
If a contractor fails to register with HMRC, they could face a £3,000 fine for not keeping CIS records, and a further £100 per month penalty per missed return (returns are due monthly – the penalty becomes £300 or 5% of the CIS deductions on the return, whichever is higher if it is 6 months or more late). With regards to potential penalty for a subcontractor not registering under CIS, the immediate consequence is a higher tax deduction rate of 30% (rather than 20%). Furthermore, even if the subcontractor fails to register for CIS, tax returns would still need to be completed. Failure to submit tax returns can lead to fines and estimated tax bills. From our experience, aside from rogue builders, the failure to register as a contractor happens more often with businesses whose main trade is not construction. These businesses can fall under CIS if their expenditure on construction operations reach a certain limit. These are called ‘deemed’ contractors. More detail follows below.
Has the worker’s employment status been considered?
Unfortunately, a common misconception is that employment status is a matter of choice; it’s not! It is important that the contractor is satisfied that a subcontractor is genuinely self-employed and that the contract and working arrangements support this to withstand any HMRC challenge. If HMRC successfully challenge the employment status of a subcontractor, then the contractor will be held responsible for the underpaid PAYE tax and National insurance contributions (NIC) for past six closed tax years, as well as interest and penalties. Furthermore, there is also a potential £3,000 penalty if incorrect employment status declaration has been made for a subcontractor on the contractor’s monthly CIS return.
Has the sub-contractor been verified?
To establish the correct rate of tax deduction, contractors need to verify a subcontractor with HMRC prior to making payment. If the subcontractor cannot be verified, then a deduction at the higher rate of 30% should be applied. Any failure to verify may result in the contractor being held liable for the underpaid tax, as well as interest and penalties.
Not submitting a return
Each month, the contractor must complete a return that details: all subcontractors used, all payments made, a declaration that the employment status of the subcontractor has been considered, and a declaration that all subcontractors have been verified.
We do come across examples where a contractor thinks subcontractors who hold gross payment status do not need to be included on the monthly return because no CIS tax has been deducted - this is not correct. All payments made to subcontractors that fall within the scope of CIS must be recorded on the relevant monthly CIS return regardless of the amount of CIS tax deducted.
Are the materials costs allowable?
Contractors are responsible for checking that the direct cost of materials claimed by a subcontractor is genuine and reasonable and has been directly incurred by the subcontractor before allowing the cost to be excluded from the amount on which CIS deductions are calculated. The wording in the legislation was changed in April 2021 so material costs are only allowable if they are a direct cost to the subcontractor for materials in relation to that particular contract. This rule was introduced to circumvent the cost of deductions being incorrectly claimed in cases where there is a chain of subcontractors.
HMRC expect contractors to have systems and processes in place to verify the cost of materials claimed. In our experience, material costs are rarely reviewed or challenged. This means that if HMRC carry out a compliance check and decide that the amount claimed was excessive, or had not been incurred by that subcontractor, it will recover any under deducted CIS tax from the contractor including interest and penalties.
Who owns the plant?
Plant such as scaffolding, cranes, earth-moving equipment, concrete pumps, and compressors are an integral part of any substantial construction project and payments for its hire with an operator are subject to CIS. However, a deduction for purposes of the CIS calculation in relation to the plant hire applies but only where the subcontractor has actually hired the plant from a third party. Where the subcontractor owns the plant (including plant being purchased via a hire purchase agreement) this cannot be treated as a deduction (materials), meaning both the plant hire and labour costs will be subject to CIS.
The treatment of plant as materials is an area to which HMRC will pay particular attention, so it is imperative that contractors have robust processes and checks in place to be satisfied that the cost of plant hire has been treated correctly. Failure to do so could leave the contractor with a substantial CIS tax liability, interest and penalties.
Deemed Contractors – have you spent more than £1 million per year on construction work over the last three years?
This question was applicable to all businesses, not just those involved in the construction industry. If the answer to this question was yes, then the company was considered to be a ’deemed contractor’ and consequently would fall under CIS. Conversely, if the annual expenditure dropped below £1m in each of the three successive years then the business ceased to be considered a deemed contractor. Unfortunately, some deemed contractors started employing creative accounting to try and avoid hitting that £1m plus threshold each year.
In response, new rules were introduced from 6 April 2021 which means that a business becomes a deemed contractor when the cumulative expenditure on construction operations exceeds £3m within the previous 12-month period. Once this criterion is met, CIS must be operated on its next payment to the subcontractor for work that falls within CIS. The key change is that this is a rolling 12-month period, so changing year-end dates would no longer work. The question of deemed contractor status needs to be considered where any organisation is entering into any significant building or re-development projects.
Other changes announced applicable from 6 April 2021
The following is a summary of the other changes which need to be considered:
• If the subcontractor undertaking CIS work is a limited company with employees used for the work and has had CIS deductions made, then it can setoff these deductions against its employer liabilities. Unfortunately, this set-off was used incorrectly by non-CIS and CIS subcontractors who are not limited companies so from 6 April 2021, HMRC can correct the amount of CIS deductions claimed where it suspects or identifies incorrect amounts have been claimed.
Consequently, should HMRC amend the Employer Payment Summary (EPS), this will lead to an underpayment and if this is not corrected in the following remittance could mean that interest and late payment penalties are charged. Additionally, HMRC can also stop the subcontractor from setting off the deductions for rest of the year.
It is estimated that these amendments will help HMRC collect an additional £20m of tax during the next two years and a further £15 million in the 2024/25 tax year.
• The final change targets fraudsters who falsely register under CIS rather than those who may have made a mistake. There is already a penalty that applies for providing false information, but this has been expanded to cover “anyone HMRC believes is in position to exercise influence and control over the business and/or the person making the CIS registration”. This would include agents, directors etc.
• From April 2022, to make the policy of incorrect set-off more robust, contractors claiming CIS deductions will have to include their Corporation Tax Unique reference (CT UTR) number or Company Tax (COTAX) reference number in their EPS return to claim the credit for the CIS deductions. HMRC will check the CT UTR against its internal systems to ensure that the business is entitled to the deductions. If a UTR is not provided or if the number is incorrect, the claim will be rejected.
If the business has lost or cannot find its CT UTR, it can request the CT UTR online. HMRC will send the reference to the business address that’s registered with Companies House.
If the company is not a limited company and therefore does not have a CT UTR, it should not claim these deductions via EPS, but should report the deductions on its Self-Assessment Tax Return instead.
A further point that needs to be borne in mind is whether the IR35 legislation needs to be considered when engaging with any sub-contractors as it will take priority over the CIS legislation.
Businesses should ensure that it has robust processes, controls and governance in place so it is fully compliant with CIS.