Perhaps the worst thing about the CIS regime is that the penalties for failing to comply – however innocently – can be very substantial, even if there is no actual tax to pay.
What is the CIS?
Basically, CIS applies to ’construction operations‘ as defined in legislation, which broadly includes the construction, alteration, demolition, repair of, or extension to, buildings or other structures. It also applies to the installation of heating, lighting, water supply, drainage, sanitation, air-conditioning or similar, painting or decorating, and the erection of scaffolding, landscaping or site clearance as part of construction works.
Whilst the scope of ’construction operations‘ is very wide, there are useful exceptions which we’ll come to later.
What are the implications if CIS does apply?
The original reason for HM Revenue & Customs (HMRC) introducing CIS (although it was of course ’The Inland Revenue‘ back in those days) was to combat sub-contractors getting paid on a casual basis but not declaring that income for tax purposes. The taxman therefore imposed a requirement for people (contractors) paying sub-contractors to withhold some of that payment and instead pay it over to the tax authorities, as a simplified version of Pay As You Earn. Alternatively, if the sub-contractor could demonstrate that he was filing tax returns on a self-employed basis, then the money could be paid gross, with no withholding.
Whilst this still applies, it is probably fair to say that with each iteration, CIS has become progressively more demanding in terms of administration and/or penalties for failing to comply with the rules – and, most importantly, it is the contractor or ‘payer’ who bears the lion’s share of the burden of administration and penalties.
What happens if I have to pay sub-contractors under CIS?
The basic requirements of the current version of CIS are:
1. Before paying a new sub-contractor for the first time, he must be ‘verified’ by checking his details with the Construction Industry Scheme Helpline (or online facility) who will advise if the sub-contractor may be paid gross, or after withholding 20% tax – or, if they cannot trace the sub-contractor’s tax records – after withholding 30% tax.
2. It is also necessary to file monthly returns (and pay over any tax withheld) of all payments made to sub-contractors in the last tax month which ends on the 5th of the calendar month. The return is due by the 19th of the month – the contractor gets 14 days to submit the return and if it’s a day late then there’s a penalty.
• Forgetting to verify new sub-contractors – or to ‘re-verify’ them again after two tax years.
• Forgetting to file monthly returns, which are required even when no tax is due or no payments have been made to sub-contractors in the month.
• Not filing returns at all because of being unaware that CIS applies!
How bad can the penalties be?
Let’s say Bill starts developing a property for re-sale on 1 January 2012, paying self-employed plumbers, joiners and electricians throughout the year. In December 2012 he finds out he is ‘caught’ by the CIS regime as a contractor, and should have been making monthly CIS returns since 19 January. Fortunately, all of his tradesmen are entitled to be paid gross, so he’s not liable to account for any tax which should otherwise have been withheld; he brings his CIS returns up to date and submits them all on 10 January 2013 - not quite 12 months after the first monthly return was due.
The first penalty is £100 for each late return – even when late by a day.
The next penalty is £200 if a monthly return is late by more than 2 months.
The next penalty is £300 for any return which is more than 6 months late...
...and another £300 if more than 12 months late.
(The last two penalties could be tax-geared if any tax were actually due: £300 is the minimum penalty.)
The key point to bear in mind is that these penalties are charged for each monthly return. Even though Bill didn’t need to withhold/pay over any tax, or do anything except file 12 ‘nil’ returns, he still faces a £5,000 penalty.
However, since October 2011, the maximum a ‘new’ contractor like Bill has to pay in penalties will normally be capped at ‘just’ £3,000. Bill might not appreciate it, but he’s very lucky: before October 2011, penalties could be as high as £80,000 if the ‘failure’ stretched over several years.
When do I have to worry about CIS – what are the exceptions?
This can be a contentious area. On the one hand there are businesses which are clearly ‘involved in construction operations’ and to which the CIS regime clearly applies. These are called ’mainstream contractors‘. On the other, there are other businesses – say a restaurant or a firm of accountants – which are clearly not caught.
But if a non-construction business, such as a restaurant chain or a large firm of accountants, spends enough on construction operations – more than £1 million a year for three years – then it can potentially become a ’deemed contractor‘ and be caught by the CIS regime. However, these businesses can ignore expenditure on property such as offices or warehouses used for the purposes of the business itself.
Private householders paying for work on their own homes will never fall within the scope of the CIS regime.
Perhaps unsurprisingly, property businesses can fall between these two categories. A property development business, which sets out to build/renovate property with a view to selling it at a profit, will probably be treated as a ‘mainstream’ contractor and have to apply the CIS regime.
It is perhaps not so straightforward for property investment businesses. This is because HMRC appears keen that such businesses be treated as ’mainstream contractors‘, so as to fall within the scope of CIS automatically.
There are two main guides to CIS:
• The CIS340 booklet: http://www.hmrc.gov.uk/forms/cis340.pdf
• The Construction Industry Scheme Reform Manual (CISR):
The CIS340 booklet says (at section 2.5) that mainstream contractors include “...any property developers or speculative builders, erecting and altering buildings in order to make a profit”. I have dealt with some Inspectors of Taxes who insist that ‘profit’ includes rental profit, rather than just profit on sale of the property.
The CISR Manual is more helpful. At CISR12040 it says of Property Developers:
“Property developers are included within the meaning of mainstream contractors because their principal business activity is the creation of buildings or other civil engineering works. The same is true of a speculative builder.
Note, however, that a 'property investment business' is not the same thing as a 'property developer'. A property investment business acquires and disposes of buildings for capital gain or uses the buildings for rental; it need not be involved in the construction of buildings. Even so, if its property estate is substantial enough, its expenditure on construction operations may well cause it to fall within the meaning of 'deemed contractor'”
It seems clear that the CISR Manual does distinguish between businesses that develop property for re-sale, and those which primarily invest in property; we should use HMRC’s manuals when it suits. But it is important to bear in mind that the legislation itself says that a contractor subject to the CIS regime is “any person carrying on a business which includes construction operations”, which is less helpful.
• Many property investors are unaware of the risks posed by the Construction Industry Scheme and how easy it is to be caught out. Whilst the maximum penalty for those who ‘stumble’ into the regime is now broadly capped at £3,000, this is still a substantial sum – and it can easily be more if tax should have been withheld from sub-contractors.
• Private individuals and businesses having work done on their own homes or properties used for their businesses should have little to worry about. But property investors who also carry out construction work should take care that they don’t fall into the CIS trap. How a property business ‘describes itself’ may be influential and the facts of how the business is actually conducted should carry even more weight.