UK consults on tackling construction industry tax abuse

Although the proposals are aimed at preventing fraud a proposed change to the definition of 'deemed contractor' could also reduce the number of non-construction businesses which fall within the scheme. There are also changes to the rules relating to materials and an expansion of the scope of the false registration penalty.

In addition the government is considering measures to be introduced at a later date which would require large contractors to conduct more extensive due diligence on the whole of their supply chain.

"The proposed additional due diligence, if pursued, will inevitably add to costs in the sector and will lead to additional burdens being imposed on counterparties to construction contracts. HMRC is looking to impose new obligations on the larger construction companies which will need to be passed down the chain so far as possible to ensure compliance," said Richard Croker a property tax expert at Pinsent Masons, the law firm behind Out-law.

The proposals were announced in March's Budget and a consultation document now sets out more details.

Under the CIS, on making a payment to a sub-contractor under a construction contract, the contractor must deduct a percentage of the payment on account of tax. Sub-contractors that are not registered with the CIS have a 30% deduction made and those registered have a 20% deduction made from their payments, unless they meet specific qualifying criteria which entitle them to receive payments gross. Contractors are required to verify the payment status of their sub-contractors with HM Revenue & Customs (HMRC) who will advise the contractor to either make gross payments or to apply the appropriate percentage deduction.

Sub-contractor limited companies that have had CIS deductions made by contractors from payments received for construction work can set those deductions set off against their employer PAYE and NIC liabilities. However, some employers are using this process to falsely reduce their tax liabilities, to create spurious sums to set off against other tax liabilities, or to create false repayments for themselves and/or their sub-contractors.

The consultation proposes a new power from April 2021 to allow HMRC to correct the CIS deduction amounts claimed by employer sub-contractors on their real time information Employer Payment Summary (EPS) returns made as employer. It seeks views on the implementation process.

The measure would allow HMRC to refuse deductions against PAYE and NICs in real time where employers claiming deductions for amounts withheld from payments made to them under CIS cannot present satisfactory evidence, such as a payment and deduction statement (PDS) from the contractor. HMRC will have the power to correct the CIS deduction claimed and to suspend any further CIS deductions for the remainder of the tax year. Where HMRC suspects collusion between the employer and the contractor it would have the power to ignore the evidence of any PDS it thinks may not be genuine.  

"This measure could have serious cash flow implications for subcontractors whose paperwork is deficient for any reason and potentially increases the cost of not having gross payment status under the CIS. HMRC will need to exercise these powers with discretion to avoid causing unnecessary hardship," Richard Croker said.

'Deemed contractors' are non construction businesses which are required to register as a contractor and operate the CIS on payments to subcontractors. Currently, 'deemed contractors' are those non construction businesses who have turned over £1m or more on construction operations over the preceding three accounting periods. They can then only fall out of the scheme if they have three successive periods where such turnover is less than £1m. This requires monitoring and the government considers it is open to abuse.

The consultation proposes that the definition is simplified so that the threshold applies on a rolling basis so where a business spends more than £3m on a construction project the scheme applies to payments over the £3m threshold. Deemed contractors will then fall out of the scheme if the contract comes to an end and they do not anticipate any further payments for construction.  

"This could be a positive change as it potentially reduces the number of deemed contractors and the administrative costs for those that remain. Deemed contractors are necessarily at the top of the supply chain and tend to be dealing with well regulated subcontractors in most cases, so there should be a lower risk of tax fraud," Richard Croker said.

The CIS only applies to the labour element of any payment and the cost of materials can thus be deducted from the contract payment before tax is deducted. The government intends to refine the materials rule so that only those materials directly purchased by a subcontractor can be deducted from the amount due to him for these purposes.

"This change limits the scope for one off payments such as contributions to landlords' costs falling outside the scheme and may make it more difficult for tax compliant businesses to avoid registration or deduction obligations which impose unreasonable costs on them," Richard Croker said.

In an early stage consultation, the government is exploring measures to give companies at the top of the supply chain a role in policing compliance with CIS further down the chain than their direct subcontractors. The government is concerned that fraudsters are inserting themselves into construction supply chains to extract cash from the tax system.

The changes are in addition to the VAT reverse charge which is being introduced from October 2020 to address the VAT element of labour fraud in the construction sector. Under the reverse charge, a customer within the construction industry receiving the supply of construction services will have to pay the VAT direct to HMRC rather than paying it to the supplier. It was originally due to apply from 1 October 2019 but was delayed a year because there were concerns that many businesses were unprepared for the changes.

The main idea floated in relation to CIS is requiring the main contractor to notify HMRC of its supply chain, a step which would impose a due diligence burden beyond that which currently applies. This could involve processes such as verifying the indirect sub-contractor with HMRC to check they are registered for CIS, VAT, other taxes; checking they are registered with Companies House (if a company or large partnership); checking how long they have been trading; checking their addresses and telephone numbers are genuine; asking for copies of their insurance cover and last accounts; checking their workers are eligible to work in the UK and checking the directors/partners are “fit and proper” persons.

HMRC would then have powers to notify the main contractor of fraudulent activity and direct them to remove the offender from the supply chain or make any future payments under the supply chain subject to deduction of tax. Penalties for failure to comply could extend to the tax lost in the supply chain from the fraudulent activity.

Another proposal, based on a similar scheme in Ireland, would be for some form of site registration system so that contractors could record which sub-contractors were working on particular sites, making it easier for HMRC to cross check payments and deductions reported by contractors against those reported by sub-contractors.

The consultation document asks for views from the construction sector on how workable these proposals would be. The consultation period ends on 28 May 2020.