Out-Law Guide | 02 Jan 2016 | 12:01 pm | 8 min. read
The Construction Industry Scheme (CIS) is a tax deduction scheme which involves tax being deducted at source from payments which relate to construction work. CIS does not apply to payments made to employees, since payments to employees are covered by the Pay As You Earn (PAYE) system of deduction of tax at source.
Although the burden of operating CIS is mainly that of the person making the payments, the rate at which tax is deducted depends on the status of the recipient. This guide will provide a brief outline of the rules governing CIS.
CIS will apply to payments made by a contractor to a subcontractor. If the subcontractor passes three tests - known as the business, turnover and compliance tests - and registers with HM Revenue and Customs (HMRC), it will receive gross payments from the contractor.
Although the best position would be for the subcontractor to register for gross payments, if the subcontractor is not eligible because it fails one of the three tests it can still register with HMRC to ensure that tax is only deducted at the lower rate of 20% instead of the higher rate of 30%.
If the subcontractor then subcontracts its obligations under the contract with the original contractor to another party, it will become the contractor in respect of its relationship with that other party. The original subcontractor will then be required to apply CIS to payments it makes to that party. Therefore, the original subcontractor could be both a contractor and subcontractor for the purposes of the CIS rules.
The CIS regime applies to all payments made under a construction contract, which is a contract relating to construction operations that is not an employment contract. CIS applies where one party is a contractor and the other party is a subcontractor.
Contractors include property developers and builders, businesses which are not in the construction business but which have spent on average £1 million or more on construction operations for the last three accounting periods and certain public bodies which have had an average annual spend of £1 million or more on construction operations for the period of three years which ended on the preceding 31 March.
A subcontractor is a person receiving payments under the construction contract and is a person who is under a duty to the contractor to carry out the construction operations, provides staff to perform the construction operations or who subcontracts those operations to another party.
The CIS regime applies to all payments made under a construction contract, which means that even if the contract covers matters other than the construction operations alone the CIS tax deduction regime will apply to all payments made under that contract. Therefore, if the contract is intended to cover other matters, it should ideally be split to ensure that only the payments in respect of construction operations fall into the CIS regime.
Some payments are exempt from the regime. For example, if a business which is not in the construction industry pays for construction work on a property that it uses itself for the purposes of its business, these payments will not be covered by the CIS. This does not apply to let property or investment properties. There are certain other exemptions to the CIS regime, but they are beyond the scope of this Guide.
CIS requires the contractor to deduct tax at source on any payments it makes to the subcontractor. The rate at which tax will be deducted depends on the registration status of the subcontractor. The following three scenarios are possible:
If tax is deducted, then a subcontractor which is a partnership or sole trader can treat this tax as income tax on profits. If the subcontractor is a company, the tax deducted can be treated as satisfying relevant liabilities which are amounts due to HMRC in respect of that company's obligations as an employer - for example, PAYE or National Insurance Contributions (NICs).
In order to be eligible to receive gross payments from a contractor, the subcontractor must provide evidence to show it satisfies the following tests:
Business Test - The subcontractor must carry on construction work in the UK, and the business must be run mainly through a bank account.
Turnover Test - This test sets minimum limits on an eligible subcontractor's annual turnover as follows:
Compliance Test – within 12 months ending with the date of application:
must have complied with all tax obligations in relation to income tax or corporation tax and supplied all information and accounts requested of them concerning the business or their share in the profits of the business. There are also certain other compliance requirements, such as having paid all NICs that are due and, if the subcontractor is a company, having complied with certain legal obligations under the Companies Act.
HMRC will review the subcontractor's compliance with these three tests each year.
The subcontractor can register for CIS online or by calling HMRC's CIS helpline. Registration information, useful forms and guidance can be found on HMRC's CIS microsite.
Further information on contractor registration and obligations can be found on HMRC's website.