Whilst off-payroll working is a hot topic at the moment, withholding tax from subcontractors in the constructionindustry has been with us for many years. But what are the rules you need to be familiar with?
The construction industry scheme (CIS) requires that all payments made by contractors to subcontractors must take account of the subcontractor’s tax status as determined by HMRC. This can mean the contractor must make a deduction from part of the subcontractor’s invoice in respect of tax and Class 4 NI, effectively making a payment on account. The cost of materials is not taken into account, only the subcontractor’s labour costs. In certain situations, for example small contracts amounting to less than £1,000 excluding materials, HMRC can authorise a contractor not to operate the scheme. Contractors who fail to operate the CIS correctly can have their own “gross payment status”, i.e. the ability to have their invoices paid in full without a withholding of tax, cancelled.
A deemed contractor is not in the construction sector, but needs to carry out construction work for its own business, for example a retailer which needs to build shops. If such a business has expenditure on construction operations over a period of three years of £1 million or more, they are classed as a deemed contractor and must operate the CIS. Construction work includes most work carried out to permanent or temporary buildings or civil engineering work.
Pro advice. Ordinary householders having work done on their own premises are not contractors.
A subcontractor is a business that carries out construction work for a contractor. They can therefore be a limited company, a public body, a self-employed individual or a partnership. Agencies who supply workers to contractors must also operate CIS on payments to those subcontractors.
Registration and deduction rates
All contractors must register for the CIS. If the subcontractor does not register for CIS, they will find that they have deductions taken from their invoices at the higher (unverified) rate of 30%. Registered subcontractors suffer a standard deduction of 20%. Subcontractors can obtain gross payment status if they have a good compliance record of paying their taxes with a turnover of at least £30,000 per year. HMRC reinstates deductions if the subcontractor appears to be non-compliant but must give the business 90 days’ notice so it can appeal if they wish to. The main contractor is also given notice that the subcontractor status has changed so it can implement it at the next payment.
Pro advice. Registration is done online or via the CIS helpline (see Follow up ).
Before making any payments to a subcontractor they haven’t paid in the previous two tax years, a contractor must verify their payment status to ensure the correct rate of deduction is taken, or none if gross payment status applies. Verification is provided via an online service (see Follow up ), with a contractor needing to be able to identify themselves as well as presenting ID information about the subcontractor. Once verification has taken place, HMRC issues the contractor with a verification number that must be included in the CIS return to support any higher-level deductions. An unverified subcontractor will have one or two letters added to the end of the verification number to indicate that they weren’t verified.
Pro advice. The verification number must also be included on the subcontractor’s payment statement if deductions have been made at the higher rate. The subcontractor needs this to claim credit for the deductions from HMRC.
Making payments under deduction
The 20% or 30% deduction is taken from labour costs, travel and subsistence, but not the cost of materials that are shown on the invoice. The contractor can ask for an estimate of the cost of materials if they are not broken down, and in the absence of this information can make a fair estimate. The contractor must keep records of the:
- gross amount of the payment excluding VAT
- cost of materials excluding VAT for subcontractors who will be liable to a deduction
- amount of the deduction, if any.
Example. A subcontractor provides an invoice for labour and materials of £600 plus VAT of £120. The contractor indicates that the materials were £200. The deduction, as the contractor is subject to the standard rate, is £400 x 20% = £80.
Pro advice. If the contractor overestimates the cost of materials to reduce the withholding, HMRC can challenge the contractor and ask them to make good the shortfall of tax.
Payments to HMRC
Contractors must pay over to HMRC the amounts deducted from payments to subcontractors to the normal monthly or quarterly payment deadlines. Any limited company which has suffered CIS deductions can set these off against the amounts to be paid over on behalf of its own employees. If it’s the case that after setting off CIS deductions, there is nothing else to pay and it still has not recovered the full amount suffered, the excess is carried forward for it to be recovered in future tax months.
Payment and deduction statements
The contractor must provide a written statement to every subcontractor from whom a deduction has been made within 14 days of the end of each tax month. Statements can be issued electronically if both parties agree. One statement per tax month can be issued, or one statement per payment, as the contractor sees fit. Contractors can design their own statement, but it must include the following information:
- the contractor’s name and tax reference
- the end date of the tax month or the date of payment
- the subcontractor’s name, UTR and verification number if a deduction at a higher rate has been made
- a gross amount of the payment made to the subcontractor
- the cost of materials that has been allowed for
- the amount of the deduction.
Pro advice. No statement needs to be provided to subcontractors who have been paid gross.
Within 14 days of the end of the tax month a contractor must send to HMRC a return of all payments made to subcontractors in the preceding tax month, regardless of whether they were paid gross or under deduction. Returns must be made online. Returns are pre-populated by HMRC with the names and UTRs of the subcontractors who have been paid previously by the contractor. Details for subcontractors who have not been paid this period should be left blank. New subcontractors, and where appropriate verification numbers, should be reported, plus the amount of payments to each subcontractor. Where no payments to subcontractors have been made in a tax month a nil return must be submitted by the 19th of the month after the tax month end.
Pro advice. If the contractor is not likely to pay any subcontractors for at least six months they can notify HMRC that they are going to suspend monthly returns for that period.
If the contractor fails to submit a monthly return on time, HMRC will charge a fixed penalty of £100. Further penalties arise if the return is still outstanding. At two months after the filing date, a second fixed penalty of £200; at six months after the filing date, a tax-geared penalty, which is the greater of £300 or 5% of the deduction shown in the return; at twelve months after the filing date, a further tax-geared penalty, which is the greater of £300 or 5% of the deductions shown in the return. A penalty can also be charged for failing to make a nil return.Before making any payments to a subcontractor they haven’t paid in the previous two tax years, a contractor must verify their payment status to ensure the correct rate of deduction. Failure to make accurate monthly returns can see the contractor’s own gross payment status removed.