Construction Industry Scheme: What the CIS rule changes mean for you

From the perspective of tax and legislative compliance, 2021 has already been a busy year.

But the added burden of Brexit red tape and coronavirus financial support measures have created a perfect storm of business adjustments.

Those businesses that operate under the Construction Industry Scheme (CIS) were already braced for the March 2021 introduction of the domestic reverse charge for VAT, which alters the way contractors and subcontractors report and pay VAT.

But the government also introduced a handful of changes to the CIS on 6 April 2021.

All are intended to stop what HMRC refers to as abuse of the CIS, which is where businesses either make false declarations to HMRC, or make mistakes. As a result, businesses gain a tax advantage that isn’t correct.

Below, we take a look at the four CIS measures that were put into place:

1. Sub-contractor companies that are also employers

2. When non-construction businesses are deemed contractors

3. Deductions for materials in sub-contractor tax deductions

4. False registration penalty under the CIS

1. Sub-contractor companies that are also employers

If a sub-contractor under the CIS is a limited company with employees used for the work, and have CIS deductions made by contractors from payments received for construction work, they are entitled to set-off deductions against their employer liabilities.

This is done via their payroll software: they send HMRC an Employer Payment Summary (EPS) return, which is completed through the Real-Time Information (RTI) system.

The intention is to ease cash flow for limited companies suffering deductions under CIS, and the set-offs occur in-year rather than at payroll year end. HMRC refers to this allowance and process as CIS set-off.

What changed and what you need to know and do

Unfortunately, the CIS set-off is used incorrectly by employers not working in construction, or sub-contractors that are not limited companies.

The claims also sometimes exceed the sums recorded as having been withheld for a particular sub-contractor on contractor returns.

To stop this happening, HMRC implemented a solution. It’s one that could have serious repercussions for any business that uses CIS set-off.

Since 6 April 2021, HMRC can correct the amount of CIS deductions claimed on a sub-contractor employer’s return where HMRC identifies or suspects inaccurate amounts have been claimed.

This will only happen if, after HMRC challenges you, you can’t provide satisfactory evidence that you’re using the CIS set-off correctly, and only if you refuse to make the corrections yourself.

HMRC also has the power as part of these measures to prevent the employer from setting further CIS deductions against their employer liabilities for the rest of the same tax year once the correction power has been used.

You’ll be able to appeal against this in the form of a review, but it’s not yet clear how.

As for actions you should take if HMRC’s remedial actions happen to you and you agree with them, any changes to the EPS will subsequently require reflecting in your bookkeeping application.

However, this could be done manually via a journal entry.

2. When non-construction businesses are deemed contractors

Some businesses outside the mainstream construction industry regularly carry out or commission construction work.

In the language of the CIS, these businesses are commonly known as deemed contractors.

They must switch to operating inside the CIS for construction operations if their average expenditure on construction operations is more than £1m each year in any three year period.

Conversely, should annual expenditure drop below £1m in each of three successive years, the business ceases to be considered a deemed contractor for expenditure on construction.

What changed and what you need to know and do

Unfortunately, some deemed contractors become creative with their accounting to try and avoid hitting that £1m-plus threshold each year.

They might deliberately incorrectly account for the work value, or adjust the timing of when it’s supposed to have happened.

Some go so far as to even adjust their accounting periods to ensure they don’t meet the threshold.

In response, since 6 April 2021, the new rules make it clearer and simpler to identify when a business is classes as a deemed supplier – and so much follow the CIS rules.

This now occurs when the cumulative expenditure on construction operations exceeds £3m within the previous 12 month period.

Once this happens, you have to use CIS on your next payment to a sub-contractor for work that falls within the CIS.

The key change is that this is a ‘rolling’ 12 month period – so changing year-end dates and suchlike will not be effective in escaping the scope of the CIS.

To stop being considered a deemed contractor, your expenditure on construction operations needs to fall below £3m within the previous 12 month period.

Alternatively, you’ll no longer be considered a deemed contractor if you make (or expect to make) no further payments on construction operations (including retention or management/administration payments) under any construction contract.

3. Deductions for materials in sub-contractor tax deductions

A basic tenet of the CIS is that, before calculating and applying the tax deduction, contractors can deduct the cost of materials that the sub-contractor has purchased.

Of course, these are only allowed if they were needed to complete the construction contract in question.

What changed and what you need to know and do

As simple as this rule seems, it was always open to interpretation.

For example:

• What if a sub-contractor also uses a sub-contractor?
• Are the materials they used also allowed to be included in the deduction calculation?

Sometimes chains of sub-contractors can build-up and this can mean the cost of deductions can incorrectly built-up.

Since 6 April 2021, the wording of the CIS ruled changed and the question to whether the above applies became simple to answer: no, it doesn’t.

A materials cost is only deductible if it’s the direct cost to the sub-contractor for materials in relation to that particular contract.

4. False registration penalty under the CIS

The final new CIS change targets actual fraudsters, rather than those who might have made an innocent mistake due to a misunderstanding of the CIS rules, or in an attempt to bend the rules to provide a better outcome.

Previously, somebody providing false information when applying for the CIS could be penalised by HMRC. This penalty would apply to either the individual concerned, or their business.

What changed and what you need to know and do

The problem arose when one person put pressure on another to provide false information.

For example, a company director could coerce the individual who manages the CIS on behalf of their own company, or even a third party.

To fix this, HMRC has expanded the scope of the penalty to cover “anyone HMRC believes is in a position to exercise influence and control over the business and/or the person making the CIS registration”.

Examples might include agents, directors, company secretaries and more.

Final thoughts on the CIS changes

As is often remarked, if you’re not doing anything wrong then you have nothing to worry about when it comes to the CIS changes.

But the issue might be that you don’t realise you’re doing something wrong, perhaps because of established practices within your business that were inherited from previous employees.

It might be that you have good intentions but have simply been misinterpreting the CIS regulations.

As such, examining all your processes surrounding the CIS in light of the above changes is absolutely necessary – especially considering the potential for penalties that some of the new measures deliver.

This can be completed as a continuation of any ongoing work to implement the domestic reverse charge for VAT.

Speaking to professionals such as accountants or agents who are experienced in the CIS is also a good idea for either an informal or formal audit.

It might be the case that spending a small amount of money at this point could save you from negative repercussions further down the line in the form of penalties from HMRC and/or reputational damage.

Editor’s note: This article was first published in March 2021 and has been updated for relevance.