What is the Construction Industry Scheme?

What is CIS

The CIS scheme is a tax deduction scheme which is exclusive to 'self-employed' subcontractors whom are working within the construction industry and are registered as such with HMRC. The Construction Industry Scheme (CIS) uses its own special definition of the term subcontractor. So even if you don't normally think of yourself as a subcontractor, you could be treated as one under CIS.

Since April 2007 all individuals that subcontract in the construction industry have to register with HMRC under the CIS scheme and obtain a Unique Tax Reference number. This UTR determines the level of tax to be deducted and paid on your behalf and is used as a payment towards your annual tax liability

Businesses in the construction industry are known as 'contractors' and 'subcontractors'. They may be companies, partnerships or self-employed individuals.

The CIS applies to construction work and also jobs such as alterations, repairs, decorating and demolition.

Brief outline of CIS

CIS will apply to payments made by a contractor to a subcontractor. If the subcontractor passes three tests - known as the business, turnover and compliance tests - and registers with HM Revenue and Customs (HMRC), the subcontractor will receive gross payments from the contractor.

Although the best position would be for the subcontractor to register for gross payments, so if the subcontractor is not eligible because they fail one of the three tests they can still register with HMRC to ensure that tax is only deducted at the lower rate of 20% instead of the higher rate of 30%.

If the subcontractor then subcontracts its obligations under the contract with the original contractor to another party, they will become the contractor in respect of its relationship with that other party. The original subcontractor will then be required to apply CIS to payments it makes to that party. Therefore, the original subcontractor could be both a contractor and subcontractor for the purposes of the CIS rules.

What is the effect of CIS applying?

CIS requires the contractor to deduct tax at source on any payments it makes to the subcontractor. The rate at which tax will be deducted depends on the registration status of the subcontractor. The following three scenarios are possible:

  • if the subcontractor does not register then the contractor must deduct tax at a rate of 30% from payments it makes to the subcontractor excluding VAT charged by the subcontractor and the cost of materials.
  • if the subcontractor does register, but does not qualify to receive gross payments, the contractor must deduct tax at a rate of 20% from payments - again, excluding VAT charged by the subcontractor and the cost of materials. Even if the subcontractor does not pass the qualifying tests to be entitled to gross payments, it would still be better for the subcontractor to register in order that tax is only deducted at 20% instead of 30%.
  • if the subcontractor registers to receive gross payments, the contractor will not deduct any amounts from the payments at all and tax is then later accounted for by the subcontractor on those payments stated in their annual tax return. This would be the most beneficial scenario for the subcontractor.

Tax is deducted at source from payments which relate to construction work. CIS does not apply to payments made to employees, since payments to employees are covered by the Pay As You Earn (PAYE) system of deduction of tax at source. Although the burden of operating CIS is mainly that of the person making the payments, the rate at which tax is deducted depends on the status of the recipient.