Under the Construction Industry Scheme (CIS), contractors deduct money from a subcontractor’s payments and pass it to HMRC. The deductions count as advance payments towards their tax and national insurance bill. Contractors must register for the scheme, but subcontractors do not have to register, although deductions are taken from their payments at a higher rate (30% rather than 20% or 0%) if they are not registered. Payments made must be declared to HMRC by the contractor filing monthly returns that are submitted online by the 19th of every month.
A deduction is the amount that a contractor has to withhold from a payment made to a subcontractor. The deduction does not apply to any part of a payment that is for the cost of materials or VAT. HMRC have always looked closely into payments made to subcontractors in relation to the cost of materials because the legislation allows for the costs of materials to be repaid to the subcontractor without making any CIS deduction. HMRC look at this as an opportunity for these costs to be inflated to minimise the deduction the subcontractor suffers.
The definition of materials is all things that a subcontractor may supply as part of the construction project. It also includes the costs of hiring any necessary equipment to carry out the project.
A check on the costs of materials is now a standard part of HMRC’s CIS compliance checks. The reasoning for this is that many contractors do not properly review any of the costs being claimed by the subcontractors or are unable to provide enough evidence to HMRC that the amounts being allowed reflect the actual cost of the materials. This creates an easy win for HMRC. If HMRC find any issues when carrying out their standard checks, they will proceed with looking at all invoices which show claims for the costs of materials for both the subcontractor in question, and usually, across all the contractor’s subcontractors. They will challenge the contractor as to why they accepted the costs of materials as being reasonable without sufficient evidence.
To avoid this risk, contractors must ensure that they have a process in place for the review of invoices which include the costs of materials. Getting the process wrong will cost the contractor money. Any penalties will be calculated on the full amount of the under deduction. Some subcontractors may not have made a return of the income or may not yet be due to make a return which means that any additional amounts due will still fall with the contractor. This can have a significant impact if the costs of the materials is a large proportion of the cost charged by the subcontractor. There is also a risk for those subcontractors who hold gross payment status (0%) as HMRC would consider this as a substantial compliance failure and may result in withdrawal of gross status.
To get it right and avoid the challenge, contractors must hold record of the invoices being checked and approved. A contractor must also be able to provide an explanation of how the costs of materials has been allowed which must be available as either a note on the invoice or as part of a recorded process of invoice checks.
If you are unsure or you require any assistance or further information on the Construction Industry Scheme, please do not hesitate to contact Charlotte Edwards (firstname.lastname@example.org) or your usual AAB contact.
To find out more about Charlotte and the Payroll and Employment Taxes team, click here.