Blog, Taxation

Essential CIS tax deductions: what contractors need to know

Understanding and navigating the complex ecosystem of the construction industry and the tax landscape is a crucial responsibility for contractors. The Construction Industry Scheme (CIS) tax deductions can be overwhelming, but mastering them is necessary for accurate tax filing and avoiding penalties. This knowledge empowers contractors, giving them control over their financial responsibilities.
 
It’s important to remember that understanding CIS tax deductions isn’t just about staying compliant with HMRC regulations; it’s also about the impact on the subcontractors. By mastering these deductions, contractors will avoid penalties and ensure fair and accurate tax filing for themselves and their subcontractors.

Understanding CIS tax

First, let’s explain what CIS actually is; it is a tax deduction scheme from HMRC that controls how workers in the construction industry will make tax payments. It also represents a set of regulations that contractors and subcontractors must comply with for their tax liabilities. The scheme was developed to simplify the tax return process for subcontractors and to try to ensure that HMRC receives proper tax revenues. Contractors deduct the tax payment from the subcontractor’s invoice in the same way an employer does with PAYE and then send it to HMRC. Subcontractors typically have to pay part income tax and part National Insurance Contributions (NICs), within these deductions.

Applications of CIS tax deductions

Businesses that carry out construction operations and incur construction expenditures must carefully assess how CIS applies to their organisation. To begin with, contractors must identify whether CIS applies to them as mainstream or deemed contractors.  These are terms which were introduced by HMRC but do not have a legal definition.  However, these can be described as follows:
 
A mainstream contractor is a company that engages in construction activities; examples of such companies include property developers and construction companies.
 
Mainstream contractors need to register themselves as CIS contractors, irrespective of the construction expenses, before paying the subcontractors.
 
On the other hand, businesses that are not considered mainstream contractors but have spent more than £3 million (excluding VAT) on construction operations over the span of the previous 12 months are known as deemed contractors. Deemed contractors invariably do not operate within the construction industry, such as supermarkets, banks, or even landlords, but whose expenditure on construction activities exceeds the specified limit.
 
Deemed contractors need to register as CIS contractors when they have surpassed the £3 million.
 
In summary, the main difference is whether the contractor’s business actually carries out construction work or not.

Scope of CIS tax deductions

Not all work under the heading of ‘construction’ is included within the scope of CIS.  HMRC outlines the types of construction work that is covered, and it includes:
 
  • Repairs and decorating
  • Civil engineering work
  • Building work
  • Dismantling and demolition
  • Installing heating and ventilation systems
  • Landscaping
  • Excavation
 
Be aware of jobs excluded from the scheme, such as carpet fitting or surveying.

Current CIS tax deduction rates

As outlined, under the CIS tax deduction scheme, subcontractors are liable for tax deductions on their invoices, which are taken out by the contractor and paid to HMRC directly. These deductions are recognised as contributions in advance for the subcontractor’s national insurance and taxes.
 
The level of tax deducted is identified using the HMRC CIS verification process and each subcontractor must be verified by the contractor prior to deducting any tax from their invoices. This must be undertaken prior to the first time you pay them, and a verification number will be issued.  This is valid for two years.
 
For verification purposes, a subcontractor must provide certain information dependent upon whether they are operating as self employed or under a limited company.  
 
If self-employed, they will need to provide the contractor with their name or business name they used when they registered for CIS, their personal Unique Taxpayer Reference (UTR), and their National Insurance number to receive the correct deduction amount.
 
If operating as a limited company, they will need to provide their company name, their company registration number and their company UTR.
 
There are 3 categories of CIS tax deduction rates:
 
  • 30% – unregistered subcontractors
  • 20% – CIS registered subcontractors
  • 0% – gross payment status

Tax deductions for unregistered subcontractors:

If a subcontractor decides not to register for CIS, they are liable to a deduction of 30% tax from their payment. Contractors can make the same deductions if they are unable to verify a company. They may need to claim a tax refund at the end of the financial year.

Tax deductions for registered subcontractors:

Businesses that register as subcontractors incur a lower tax deduction of 20%. They are also known as net subcontractors. Usually, small subcontractors prefer to register with CIS to avail 20% tax deduction from the payment received from the contractors. This enables them to spread the tax burden rather than paying the whole amount at the end of the year.

Tax deductions for subcontractors who have received gross payment status:

Subcontractors with gross payment status will receive full payment without any tax deductions from the contractors. To achieve gross payment status, HMRC will require you to ‘pass’ certain criteria such as clear tax and NI compliance, turnover and main area of business. In this situation, subcontractors have to declare their income and pay all tax and NI owed at the end of the year.

How to make CIS deductions

It is important for contractors to understand how CIS deductions apply to subcontractor invoices.  Before making any calculations, they should deduct the items the subcontractor has paid for, which are exempt.  Examples of those which should deducted are:
 
  • Value Added Tax charged by subcontractors.
  • Cost of materials purchased by subcontractors
  • Equipment hire costs
  • Used up materials
 
To avoid mistakes in tax deductions, contractors must focus on subcontractors’ invoices to separate labour costs from the CIS subcontractors’ allowable expenses.

How to calculate CIS tax deductions?

The basics of calculating CIS deductions are essential to be aware of so that contractors can make the correct payment to the subcontractors.  Contractors have to submit the actual tax amount to HMRC which might lead to penalties in case of wrong calculation. 
 
Below is a step-by-step guide for calculating CIS deductions.
 
  1. Verify the subcontractor registration: Before paying subcontractors, always check their registration with HMRC using their Unique Taxpayer Reference (UTR) number and other required details.
  2. Calculate the deduction rate: Contractors can find the appropriate CIS tax deduction rates (0%, 20%, and 30%) based on their registration verification.
  3. Calculate the total deduction amount: Contractors must multiply the total gross amount by the deduction percentage rate after excluding the allowable expenses and VAT.
  4. Subtract tax from the total payment: To calculate the net payment contractors will make to the subcontractors, subtract the total deduction amount calculated above from the total gross amount.
  5. Send payment to subcontractors: Now, pay the net amount to the subcontractor and submit the tax deduction amount to HMRC monthly.

Final thoughts

Staying informed about the CIS tax laws is never easy, but construction companies typically face significant challenges because of the intricacies of tax regulations for subcontractors. Many contractors hire permanent employees rather than subcontractors simply to forgo the possible complications. 
 
In these uncertain times, working with experienced construction accountants can provide a sense of reassurance. Golding Accountancy is known for its accounting services geared towards modern contractors.  They can help take your construction business to the next level by customising their services to meet your unique needs. Schedule a free consultation to determine how we can support you in making confident financial decisions.
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