Introduced by HMRC, the Construction Industry Scheme (CIS) is a statutory tax scheme that provides for certain payments under the ‘construction contracts’.
Furthermore, these payments are to be subject to a tax deduction by the contractor (payer), unless the subcontractor (payee) registers with HMRC to become eligible for payments gross without any tax deductions.
As per the employment law in the UK, a contractor is a business or any other concern that pays subcontractors for doing construction work.
Private householders, however, are not counted as contractors and therefore, are not covered by this scheme. Let us take a closer look at CIS and its various attributes.
The Construction Industry Scheme applies to payments done to a subcontractor by a contractor. Furthermore, if the subcontractor passes three tests (business, compliance and turnover tests) and registers with HM Revenue and Customs (HMRC), they will receive gross payments without any tax deductions from the contractor.
Even if the subcontractor fails to register for gross payments or if becomes ineligible (by failing one of the tests), they can still register with HMRC to receive tax deductions at a lower rate of 20 percent instead of 30 percent.
When Does CIS Apply?
The CIS applies to payments that are made under a construction contract. This contract relates to construction operations and is not an employment contract. Furthermore, CIS applies in scenarios wherein one party is a contractor and the other party is a subcontractor.
In general, contractors include builders, property developers, businesses which have spent £1 million or more on an average on construction operations for three accounting periods and public bodies which have had an average annual expenditure of £1 million or more on construction operations for three years or more.
On the other hand, a subcontractor is a party that receives payments under the construction contract and carries out construction operations, provides the workforce to perform operations or subcontracts the operations to another party.
The CIS applies to all forms of payments made under a construction contract. This means that even if the contract comprises matters outside of construction operations, the CIS tax deduction will apply to the payments made under the contract. Therefore, if you need to draft a contract that aims to cover other matters as well, it should be divided into sections to make sure that the only the construction operations payments fall into the CIS regime.
There are certain payments, however, which are exempt from the scope of CIS.
For example, if a business that is based out of the construction industry pays for construction operations on a property that is intended for conducting its own business, these payments will not be taxable by the CIS.
What Is The Effect Of CIS Applying?
Under CIS, the contractor is required to deduct tax at source on all payments made to the subcontractor. Furthermore, the rate of tax depends on the registration status of the subcontractor. There are three possible scenarios here, including:
- if the subcontractor does not register with the HMRC, the contractor must calculate tax at a rate of 30 percent from the payments it makes to the subcontractor (excluding the cost of materials and the VAT charged by the subcontractor);
- if the subcontractor registers but fails to qualify and receive gross payments, the contractor can deduct tax at a rate of 20 percent from payments after excluding the cost of the materials and the VAT charged by the subcontractor;
- if the subcontractor registers with the HMRC to receive gross payments, the contractor cannot make any tax deductions has to give the full payments. The subcontractor is later accounted for those payments when filing for annual tax return.
How Does a subcontractor Become Eligible To Register For Gross Payments?
To receive gross payments from a contractor, the subcontractor must submit proof of eligibility after qualifying the following tests:
The subcontractor must carry out construction work in the United Kingdom and the business must make transactions mainly through a bank account.
This test sets the minimum limits on the subcontractor’s annual turnover once it becomes eligible. The limits are as follows:
- The turnover for an individual trader must be at least £30,000 from construction work;
- The payments received under the construction operations contracts (excluding the cost of materials) for a partnership, must not be less than £200,000 and also the multiple turnover thresholds. This threshold can be described as the sum of each individual member of the partnership multiplied by £30,000;
- A company’s threshold is set at the lower limit of £200,000 and this amount is calculated by multiplying the number of directors in the company by £30,000.
Furthermore, this threshold comes down to £200,000 if the company is a close in nature (has less than five controlling parties.) This amount is calculated by multiplying the number of shareholders by £30,000.