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If you're a contractor or a subcontractor in the construction industry, your cashflow planning must take the Construction Industry Scheme (CIS) into account.
In simple terms, contractors are required to deduct between 20% to 30% from every invoice paid to subcontractors. This money is paid to HM Revenue and Customs (HMRC). The payment becomes an advance on the tax and national insurance that the subcontractor will be expected to pay.
In practice, the CIS rules are complex, and the amount deducted varies due to many different factors. What's important is that contractors register for the scheme, make the right payments to HMRC and keep detailed records of what was paid and why.
All contractors and subcontractors in the construction sector must abide by the scheme, which was set up to reduce tax evasion in the industry. For cashflow purposes, it's important to understand how the scheme works and its potential impact on your business.
For the purposes of CIS, a contractor is an organisation that pays other businesses to perform construction work. For example, a building company may hire a plumbing business to perform specific tasks on a project. The plumber is considered to be a subcontractor, regardless of whether they are a self-employed individual or a plumbing firm.
Employees and building projects on behalf of private home owners are outside the scope of the CIS.
A sub-contractor can be self-employed, or the owner of a limited company or a partner in a partnership.
The precise rules about who the scheme applies to are more detailed and you should confirm how they apply to your business before making payments.
All contractors must register with HMRC before taking on any subcontractors.
Subcontractors are not required to register. However, it is recommended that you do, as this could offer cashflow benefits. As a registered subcontractor, the basic deduction rate reduces from 30% to 20% and it may be possible to cut it to zero under specific circumstances.
It's possible for your business to be both a contractor and a subcontractor.
A construction project comprises many different tasks which take place over a period of time and not all of these fall within the scope of the scheme. The CIS applies to any work considered to be practical construction, if it takes place in the UK. This work includes:
It does not include tasks that relate to the construction process, such as providing facilities for staff (such as a canteen or accommodation), or surveying or architectural work. Carpet fitting may be excluded if it's provided under a separate contract from other work
Before a subcontractor's bill can be paid, the contractor must work out how much of that payment should be held back and paid over to HMRC. The amount of this deduction may be different from one subcontractor to another. The best way to find out what the deduction percentage should be is to contact HMRC, who will verify whether the subcontractor is registered and then confirm the rate of deduction.
It's possible that a subcontractor can be paid gross - that is, without any deductions. However, this should only be done based on HMRC's instruction.
Step 1 - The contractor receives an invoice from the subcontractor.
Step 2 - The contractor must calculate the deduction.
Step 3 - Details of how the deduction was calculated are documented in detail.
Step 4 - Payment of the net amount is made to the subcontractor.
Step 5 - A statement of deduction is prepared and supplied to the subcontractor.
The contractor prepares a return for HMRC, which documents all the payments made to subcontractors along with details of deductions.
The total of these deductions is paid over to HMRC, usually on a monthly basis.
A subcontractor's bill will typically comprise several different elements. Many of these must be removed before the deduction is calculated. Items to be excluded from the deduction calculation include:
It's important to check the details of these costs, to confirm which items are allowable deductions under the CIS. If a subcontractor is unable to supply details of their costs, the contractor should make a fair estimate. It's important to note that if the material deduction seems unreasonable and cannot be verified with evidence, HMRC may require the contractor to make a further payment to cover the amount they assess to have been calculated incorrectly.
Once these items have all been deducted, the CIS percentage can then be applied to the net amount. This percentage is typically supplied by HMRC.
The subcontractor presents an invoice for £10,000 plus VAT, totalling £12,000.
The invoice specifies that the £10,000 includes:
This totals £3,000, all of which can be excluded from the deduction calculation.
With the removal of the VAT and the other amounts above, the amount to be included in the calculation is now £7,000.
The CIS deduction percentage from HMRC is 20%. Therefore, the contractor must hold back £1,400.
Under a separate scheme, the VAT reverse charge, the contractor must also hold back the VAT of £2,000.
The contractor pays the subcontractor £8,600 and pays HMRC £3,400 (the total of the VAT and the CIS deduction).
Whether you're a contractor or subcontractor, you need to stay alert to the implications of the CIS, in order to manage your finances as effectively as possible and get your bookkeeping right.
Under the CIS, contractors are obliged to pay some of the money billed by subcontractors to HMRC. This makes little difference to cashflow, because the amount being paid is the same, it's just split between two different recipients.
However, this does require the contractors to keep detailed records and accounts, and produce specific returns on a regular basis. There's a risk of the contractor being required to make good any amounts that HMRC considers it should have deducted from subcontractor payments, but has not. Because a subcontractor’s status under CIS can change, there's a risk that contractors deduct too little because they are not aware of the status change.
Under CIS there's a good chance that many bills submitted to contractors will not be paid in full, because of the amount deducted and paid to HMRC under the CIS. Of course, this money isn't lost, it's simply held on account against future tax liabilities. It's effectively pay-as-you-earn tax accounting. There are actions that help minimise the impact of this, such as registering as a subcontractor and ensuring that all bills clearly itemise those elements that can be deducted, such as cost of materials.
Cashflow planning is particularly important where there are employees to pay and potentially other subcontractors who are working for you.
The CIS, while simple in theory, can be extremely complex in practice. It's wise to take professional advice about setting it up and operating it in your business, whether you're a contractor or subcontractor. There are a number of software tools that can help with issues and calculations around CIS, including many accounting systems.
Detailed information about the CIS is available from the Gov.uk website.
While planning and preparation is often enough to help construction firms manage their cashflow, sometimes circumstances disrupt what should be a relatively smooth operation. A customer pays late, a significant tax bill arrives unexpectedly, or you need cash to invest in a new commercial project.
Whatever the reason, we're here to help. Every day our business finance specialists take calls from firms that need an extra injection of cash - sometimes urgently.
If you're looking for a new source of working capital, for whatever reason, we can probably help you secure it at a competitive rate. To find out more, get in touch with us today.
As a founder of multiple businesses, Jamie believes that mindset, discipline and ambition are key drivers for success, both for his businesses and for his clients.
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