The construction industry scheme for tax practitioners
Tax consultant Tim Palmer, a partner at Palmer Consultancy, spoke to members of ICAEW’s Tax Club for younger tax practitioners about the regulatory and reporting requirements of the construction industry scheme (CIS).
Tim addressed the London audience on a number of key considerations for contractors and subcontractors operating in the industry, including: when the CIS rules apply; and what the definitions of a contractor and a subcontractor are for tax purposes.
When do the rules apply?
Tim explained that for the construction industry scheme (CIS) to apply, three things need to happen:
- there must be a contractor;
- the contractor must engage with a self-employed subcontractor (or a subcontractor company/partnership); and
- the subcontractor must perform construction operations.
If all three elements are present, the CIS applies. This means the contractor is required to verify the tax status of the subcontractor, possibly deduct tax at source from the subcontractor’s pay (either 20% or 30%), file monthly CIS returns and keep records detailing the gross amount paid to each subcontractor and any deductions made.
Definition of contractor
A contractor is “any person carrying on a business which includes construction operations” as defined in s59, Finance Act (FA) 2004. A person (ie, a business) will also be deemed to be a contractor if average annual expenditure on construction operations exceeded £1m in the three years up to the end of the last period of account. For example, if a retail company spends £10m on renovating its premises the company would be a deemed contractor.
Definition of subcontractor
A subcontractor is defined in s58, FA 2004 as anyone who is “under a duty to the contractor to carry out operations, or to furnish his own labour… or the labour of others in the carrying out of the operations”. This definition can be applied to a self-employed person, a person running a business in partnership, a company or a public body.
Subcontractors are not required to register with HMRC but if they do not, tax will be deducted from their payments at a higher rate than for those who have registered.
The legislation is very clear on what is and what is not a construction operation. Section 74, FA 2004 contains a ‘yes’ list and a ‘no’ list. Under s74(2), FA 2004 the general rule is that any “construction, alteration, repair, extension, demolition or dismantling of building or structures” is a construction operation. Internal cleaning is within the definition of construction operations as is the installation (but not repair) of substantial systems such as air-conditioning, drainage or fire protection.
The professional work of architects and surveyors is not a construction operation; however, any architect’s or surveyor’s fees for managing the design project are within the scheme (s74(3), FA 2004). Carpet fitting is another example of an activity that is specifically excluded from the definition.
Tax status of the subcontractor
Tim emphasised that one of the biggest problems in the construction industry is determining whether an individual subcontractor is in fact self-employed. The onus is on the contractor to verify the status of the subcontractors they engage before making payment to them. This responsibility is enforced by box six on the contractor’s monthly CIS return form that requires the contractor to tick the box to confirm the employment status of each contractor has been verified and no payments are made under contracts of employment. PAYE overrides CIS and HMRC is, not surprisingly, keen to ensure individuals are taxed correctly. A penalty of up to £3,000 could be levied if the contractor gets it wrong.
In the case of Castle Construction (Chesterfield Ltd) v HMRC (2008) UK SpC 723, HMRC argued that 321 workers were employees of the company and were not self-employed. Castle Construction appealed against the determination raised by HMRC and won, as it was found that there was no mutuality of obligations. The workers were able to turn down work offered and there was no obligation for Castle Construction to offer them regular work. Other factors considered included the requirement for individuals to pay for their own work clothing, tools and equipment and to rectify any poor workmanship in their own time.
Gross versus net
Once it has been established that the subcontractor is self-employed, the contractor will need to consider how to make payments to that individual. Most subcontractors prefer to be paid gross rather than taxed at source each month, and so when registering with HMRC online, it is possible to apply for gross payment status.
Before making a payment to a subcontractor, the contractor must verify the status of a subcontractor (either using HMRC software or commercial software). HMRC will respond in one of three ways:
- the subcontractor is registered with HMRC and is paid gross without the deduction of tax;
- the subcontractor is registered with HMRC and is paid net after the deduction of basic rate tax;
- or the subcontractor is not registered with HMRC and 30% tax must be deducted at source.
In some cases HMRC will downgrade a subcontractor from gross payment status to net payment status, particularly where self assessment returns have been filed late.
Once the status of the subcontractor has been determined the contractor will pay the subcontractor in accordance with the rules. Tim used the illustration above to demonstrate that some items must always be paid gross, even to a net payment status subcontractor.
Tim concluded the evening by summarising the administrative burdens the CIS places on contractors, and this is before considering the implications of Making Tax Digital; another hurdle for the industry to overcome in the near future.
If you would like to learn more about the construction industry you can register for the ICAEW Tax Faculty webinar on 17 March 2017 at icaew.com/taxwebinars
The 2017 Tax Club series of events takes place at The Globe pub in Moorgate, London. For future dates and topics scheduled for discussion email firstname.lastname@example.org
|This article first appeared in the March 2017 edition of Taxline under the title "Getting on top of the construction industry scheme" .|
About the author
Sarah Ghaffari, technical manager with responsiblity for SME business tax,