Tax and the construction industry
The construction sector is again under the spotlight. Tim Palmer and Mark Rubinson of Arram Berlyn Gardner review in depth the forthcoming tax changes. They look at the basics of the construction industry scheme, how the changes affect contractors and subcontractors, and illustrate their points using three examples.
On 1 March 2021, the new VAT domestic reverse charge will come into play within the construction industry. It was originally due to start on 1 October 2019, but was deferred for a year.
HMRC has now announced a second deferral to this anti-fraud measure, and it will now start on 1 March 2021.
In general terms, under the domestic reverse charge, the VAT-registered subcontractor performing qualifying ‘construction operations’ will not charge its contractor VAT for services rendered. Instead, the contractor will pay the VAT over to HMRC on its behalf. We will look at this very important area later in this article.
HMRC also published, on 19 March 2020, a consultation document entitled Tackling Construction Industry Scheme Abuse. We will again review the proposed changes later.
Back to basics
Compliance with the considerable CIS tax obligations is a big, regular ask for contractors, in particular, within the industry. These include:
- the completion of monthly CIS tax returns;
- ensuring the subcontractors that they use are genuinely self-employed;
- verifying new subcontractors with HMRC;
- deducting the correct amount of CIS tax from their net registered subcontractors;
- producing statements each month to certify the CIS tax deducted; and
- ensuring that the subcontractor is really performing qualifying ‘construction operations’.
CIS applies if a contractor engages a subcontractor to perform construction operations. In practice, it is the question of ‘Is this really construction operations?’ that can cause particular problems for contractors and their tax advisers.
Construction operations
This term is very widely defined. As a guide, it covers almost anything that is done to a permanent or temporary building, structure, works or civil engineering or installation, which includes the following.
1) The construction, alteration, repair, extension, demolition or dismantling of buildings or structures (whether permanent or not) including offshore installations.
2) The construction, alteration, repair, extension or demolition of any works forming, or to form, part of the land.
3) The installation (ie, not repair) in any building or structure of systems (note it has to be a system) of heating, lighting, air conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection.
It is the installation only. For example, a subcontractor repairing an air conditioning system would not be performing construction operations. Additionally, it has to be the installation of ‘a system’. If you simply install fire extinguishers in a building, this is not substantial enough to be classed as ‘installing a system’.
4) The internal cleaning of buildings and structures so far as carried out in the course of their construction, alteration, repair, extension or restoration.
5) Painting or decorating the internal or external surfaces of any building or structure.
6) Operations that form an integral part of, or are preparatory to, or are for rendering complete, such operations as previously described, including site clearance, earth-moving, excavation, tunnelling and boring, laying foundations, erecting scaffolding, site restoration, landscaping and provision of roadways and other access works.
Architects
The work of architects has to be looked at closely within CIS. The initial design of the building would be excluded from CIS. However, if the architect agrees to manage the development project for the contractor (as many regularly do), the exclusion would no longer apply.
Activities that are not construction operations
The legislation states certain operations are held not to be construction operations for the purposes of the scheme. These include:
a) drilling for, or extraction of, oil or natural gas;
b) extraction (whether by underground or surface working) of minerals and tunnelling or boring, construction of underground works, for that purpose;
c) manufacture of building or engineering components or equipment, materials, plant or machinery, or delivery of any of these things to site;
d) manufacture of components for systems of heating, lighting, air conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection, or delivery of any of these things to site;
e) the professional work of architects or surveyors, or of consultants in building engineering, interior or exterior decoration or the laying out of landscape (but see above);
f) the making, installation and repair of artistic works, being sculptures, murals and other works, which are wholly artistic in nature;
g) signwriting and erecting, installing and repairing signboards and advertisements;
h) the installation of seating, blinds and shutters; and
i) the installation of security systems, including burglar alarms, closed circuit television and public address systems.
Additional points
The installation of artistic works can also cause CIS compliance problems in practice. To qualify for the CIS exemption, the works must be wholly artistic, with no building function.
For example, if beautiful new artistic windows, with superb artwork on them, are installed in a hotel conservatory, the installation would be regarded as construction operations. The window lets in light, has a building function, and would hence be caught. The legislation is notoriously strict!
Example 1
Fictional housebuilder Bovit buys a piece of land in Exeter, Devon, and constructs a beautiful new home on the land.
It engages 14 different subcontractors to do various works for it, in order to complete the construction of the domestic property.
Which subcontractors are performing ‘qualifying construction operations’ and are therefore within CIS? See Table 1.
| Expenditure (excluding VAT) |
Cost (£) |
Within CIS? |
|---|---|---|
| Site clearance and tree felling | 3,000 | Yes |
| Erecting scaffolding |
1,000 |
Yes |
| Architects fees for designing the home |
5,000 |
No |
| Transport of building materials to the construction site | 1,000 |
No |
| External cleaning of the building during its construction |
1,000 |
No |
| Installation of a heating system |
3,500 |
Yes |
| Carpet fitting |
2,000 |
No |
| Payment of an architect to manage the project |
5,000 |
Yes |
| Repair of lighting circuits |
1,000 |
No |
| Installation of blinds and shutters |
1,200 |
No |
| Fitting and supplying of fire extinguishers |
500 |
No |
| Installation of a burglar alarm system |
1,000 |
No |
| Transport of material on the building site |
800 |
Yes |
| Landscaping to complete the building project |
2,000 |
Yes |
Deduction of CIS Tax
When a contractor verifies a new subcontractor, HMRC will advise the contractor to pay them either gross or net. If the subcontractor is registered net within CIS, they will have a 20% deduction made from their payments. A 30% deduction is made if subcontractors are not registered within the CIS.
Example 2
Bovit is advised by HMRC, upon verification, that Fred the subcontractor is registered net.
From which items does Bovit deduct 20% tax on the following bill, rendered by Fred? See Table 2.
| Expenditure |
Cost (£) | Comment |
|---|---|---|
| Labour | 2,000 | Deduct tax |
| Materials (cost to Fred £200) |
300 | Deduct tax from the £100 profit element |
| Travelling to site |
120 |
Deduct tax |
| Plant hire used with no operator |
500 | Pay gross |
| Subsistence |
40 | Deduct tax |
Recent CIS Consultation Document
Back in March, HMRC published Tackling Construction Industry Scheme Abuse.
The Tax Faculty will be responding and is aiming to submit its response ahead of the closing date of 28 August 2020. If you have any comments that you would like to include in the Tax Faculty’s response, please email taxfac@icaew.com
The areas covered by the consultation include the following:
1) CIS deductions claimed against PAYE
The document states: “HMRC is aware that CIS deductions suffered are being claimed:
- by employers not working in construction;
- by subcontractor employers that are not companies; and
- that exceed the sums recorded as having been withheld for a particular subcontractor on contractor returns.”
HMRC proposes that a “new provision will be introduced from April 2021 to allow HMRC to correct the CIS deductions figure claimed on the subcontractor employer’s EPS return where there is no satisfactory evidence to support it”.
2) Deemed contractors
HMRC feels that the current ‘deemed contractors’ rule is open to abuse and will make changes to rectify the position.
Businesses spending above a certain amount on construction operations have to operate CIS when the threshold is reached. It is proposed that construction expenditure will be duly calculated on a ‘rolling basis’. Once the threshold has been reached, the business will have to register for CIS as a contractor, if it has not already done so.
The business will then commence operating CIS on the next payment that it makes to a subcontractor in respect of the construction operations undertaken.
3) Deductions for materials
The government is going to tighten up the materials deduction rule. It is proposing that a deduction can only be made where a subcontractor has directly purchased the materials to be used in completing that contract.
4) Penalties
The government has decided that the false registration penalty will be expanded in scope to include a ‘relevant person’ including an agent, director, company secretary or anyone else exercising control and direction over the business making the registration application.
It is proposed that all of these changes and amendments will come into effect from April 2021.
5) Construction supply chains
HMRC has also asked for ideas to combat fraud in construction supply chains. Discussions with larger contractors will shortly take place in this regard.
The New VAT Domestic Reverse Charge for Building and Construction Services
This comes into effect from 1 March 2021. In very general terms, the customer (the contractor) receiving the affected construction services will have to account for and pay the VAT to HMRC instead of the supplier.
This is a considerable change to the VAT construction process and will increase the importance of a business’s existing CIS invoicing procedures and accounting systems.
The reverse charge will broadly affect supplies of building and construction services that also need to be reported under CIS in the UK, at the standard or reduced VAT rates. The charge does not apply to zero rated or VAT exempt transactions.
Example 3
An insurance company (the end user) contracts with Bovit to extend its Beaconsfield office, on 1 April 2021.
Bovit subcontracts the majority of the work to Lewis Ltd. Both Bovit and Lewis Ltd are VAT registered. Lewis Ltd does not charge VAT on its bill to Bovit.
Bovit is the customer (ie, the purchaser of the services) and will account for the VAT due to HMRC.
Bovit will declare the VAT due as output tax on its own VAT return. Bovit will also be able to reclaim the VAT as input tax under the normal rules. In turn, Bovit will charge standard-rated VAT to the insurance company, which is the end user. Accordingly, if a contractor receives a service subject to the VAT reverse charge from its subcontractor, it must account for the VAT in Box 1 of its VAT return, and then also recover it simultaneously on the same actual VAT return in Box 4, subject to the usual VAT rules on input tax deduction.
End users
Sales to end users will be outside the scope of this reverse charge.
The end user will be a business that does not make supplies of construction services, such as a supermarket or football club.
VAT will be charged as normal by the building business to the end user, and the VAT domestic reverse charge will not apply.
Conclusion
Big changes will shortly be introduced into CIS compliance.
Tax advisers must warn their construction clients of the changes, educate them, liaise with them and keep them abreast of developments.
The clients must have up-to-date software and accounting processes to enable them to account for and cope with the new CIS VAT changes from 1 March 2021.
It seems there are challenging times ahead in the CIS world.
About the authors
Tim Palmer CTA ATT is a Tax Consultant at Arram Berlyn Gardner
Mark Rubinson FCCA is a Partner at Arram Berlyn Gardner