Running CIS Deductions on a Subcontractor Payment

Eight thousand four hundred and twenty pounds, payable Friday

The groundworks invoice came in on the tenth. One line — groundworks to rear extension as agreed — and a figure of £8,420 before VAT, from a firm that has been on three of your jobs and has never sent a breakdown in its life. The pay run is Friday, the bookkeeper wants a number, and the number is not the one on the invoice.

Three separate questions stand between that document and the transfer, and only the last of them is arithmetic. Whether this payment falls inside the Construction Industry Scheme at all is settled by the contract, not by the invoice. What percentage applies is settled by HMRC, not by what the subcontractor believes their status to be. And the sum the percentage is applied to is settled by what the invoice can actually evidence, which is why a single-line invoice is a problem before it is a document. Take them out of order and the usual result is a deduction taken on the whole £8,420, which is over-deducting by several hundred pounds and is not something you can quietly hand back a fortnight later.

Whether the payment is inside the scheme is settled by the contract

The scheme is in Chapter 3 of Part 3 of the Finance Act 2004, worked through in detail by HMRC's CIS340 guide, and it bites on a person the Act calls a contractor. Section 59 draws that net in two ways. A mainstream contractor is a business whose trade is construction — a builder, a groundworks firm, a developer, a labour agency supplying construction workers. A deemed contractor is a business that is not in construction at all but spends heavily on it: since 6 April 2021 the test is whether construction expenditure has exceeded £3 million in the previous twelve months, on a rolling basis, replacing the older three-year averaging. A supermarket chain, a housing association and a manufacturer refitting a plant all land inside on that limb, usually late and by surprise. A private householder having their own house extended is not a contractor at all, in either sense, and never has to think about any of this.

The second half of the test is the work rather than the payer. Section 74(2) lists what counts: construction, alteration, repair, extension, demolition and dismantling of buildings and structures; works forming part of the land, from walls and roadworks to pipelines, sewers and industrial plant; the installation in a building of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply and fire protection; internal cleaning done in the course of the construction work; painting and decorating internal and external surfaces; and operations integral or preparatory to those, which is where site clearance, earthmoving, excavation, tunnelling, laying foundations, erecting scaffolding, site restoration, landscaping and access works come in. Section 74(3) then lists what is out, and the exclusions are less intuitive than the inclusions.

Two traps sit in that pair of lists. The first is that manufacture and delivery are outside while installation is inside, so a joinery firm that makes windows in its workshop and delivers them is outside the scheme, and the same firm fitting them into the openings is inside — and if one contract covers both, the mixed-contract rule pulls the whole payment in, including the manufacturing element. The second is that professional work is outside: the structural engineer's calculations and the surveyor's report are not construction operations, however central they are to the job. Where a contract genuinely spans both, the scheme does not let you split it into a taxable half and an untaxable one.

Before any of that, though, decide what the person actually is. The scheme applies to subcontractors, not to employees, and it is not a status test — paying somebody under deduction does not make them self-employed, and HMRC's monthly return carries an explicit declaration that you have considered the employment status of everyone on it. Where the off-payroll working rules in Chapter 10 of Part 2 of the Income Tax (Earnings and Pensions) Act 2003 apply and produce a deemed employment payment, PAYE takes precedence and the scheme does not touch that payment. The agency rules in Chapter 7 of the same Part work the same way. Getting this wrong is more expensive than getting the percentage wrong, because the shortfall is employer's National Insurance rather than tax on account.

Nil, twenty or thirty is HMRC's answer, not the subcontractor's

You do not decide the rate and neither does the subcontractor. Section 69 of the Finance Act 2004 and regulation 6 of the Income Tax (Construction Industry Scheme) Regulations 2005 require you to verify with HMRC before the first payment under a contract, giving your own accounts office and employer references together with the subcontractor's name and unique taxpayer reference — plus the company registration number for a limited company, or the firm name and partnership UTR for a partnership. HMRC answers with a status and a verification reference number, and that answer is the instruction. The three outcomes are gross payment, payment under deduction at the standard percentage, and payment at the higher percentage. HMRC's contractor guidance on making deductions states those percentages as 20 for a registered subcontractor and 30 for an unregistered one, with nil for gross status; CIS340 itself now points to that page rather than printing a rate, because the rate is the sort of thing that changes without the guide being reissued.

The higher rate is not a penalty for being a bad business. It is what applies when the subcontractor is not registered for the scheme, and equally when they are registered but HMRC cannot match the details you supplied to a record. An unmatched verification comes back with a reference ending in one or two letters after the ten digits, and that suffix is the whole message: deduct at 30 until the details are corrected and the subcontractor is re-verified. An unmatched result is very often nothing worse than transposed digits in a UTR, or a trading name given where the registered name is on the record. It is worth one phone call before the pay run rather than a repayment claim after it.

Gross status is not a favour either — it is a set of tests in Schedule 11 to the Finance Act 2004, applied to the individual, the firm or the company. There is a business test, that the work is construction carried on in the United Kingdom through a bank account; a turnover test measured on construction turnover net of materials, at £30,000 for a sole trader, £30,000 per partner or £100,000 for a firm, and £30,000 per relevant director or £100,000 for a company; and a compliance test on tax obligations over the preceding twelve months. From 6 April 2024 the compliance test also takes in VAT obligations, and HMRC gained a power to cancel gross status immediately in cases of serious fraud. A subcontractor who loses gross status will be told, and so will you, and the change applies from the date HMRC gives rather than from the date you notice it.

One thing that catches new contractors: a gross-status subcontractor is inside the scheme, not outside it. You verify them, you deduct nothing, and you still report the payment on the monthly return. The nil rate is a rate.

1. Verify before the first payment under the contract, not before the first job — a new contract with the same subcontractor does not need a fresh verification if you have paid them and included them on a return in the current tax year or the two before it.
2. Give the exact registered details: legal name rather than trading name, the UTR as printed, and the company registration number for a limited company. A partnership needs both the partnership's details and those of the partner you are contracting with.
3. Record the verification reference number against the subcontractor, and note whether it came back matched or unmatched.
4. Apply the rate HMRC gave you from that point on, including where it contradicts what the subcontractor has told you, and including where it changes mid-contract because HMRC has notified a change.
5. Re-verify when the subcontractor has not appeared on one of your returns in the current or previous two tax years, and whenever an unmatched result is corrected.
6. Keep the verification result with the payment records. It is the only evidence that a 30 per cent deduction was HMRC's answer rather than your assumption.

The tax month, and the four dates inside it

The scheme's calendar is not the calendar month. A tax month runs from the 6th to the 5th, so a payment made on 4 May belongs to the month ending 5 May and is reported and paid over in the same cycle as one made on 8 April. Payment date governs, not invoice date and not the date the work was done, which means a payment run held back three days to the following Tuesday can cross a month boundary and change everything downstream of it.

Two documents come out of each month. The monthly return, CIS300, is due by the 19th and reports every subcontractor paid, the gross amount excluding VAT, the materials cost and the deduction. It carries two declarations that are easy to click past and are not decorative: that the employment status of every subcontractor listed has been considered, and that every one of them has been verified or has appeared on a recent return. Alongside it, each subcontractor from whom a deduction was taken must be given a payment and deduction statement within fourteen days of the month end — the same 19th — showing the same figures. That statement is their only evidence for reclaiming the money, and a subcontractor who cannot produce it has a genuine problem that started on your desk.

The money itself follows on the 22nd where it is paid electronically, or the 19th where it is not, and it goes over with the PAYE for the same month. A business whose average monthly PAYE and CIS liability is under £1,500 can pay quarterly. If you paid nobody in a month you still file — a nil return, or a notification of inactivity that covers you for up to six months, after which the returns are expected again. Doing neither is the most common way a compliant firm collects penalties for months in which it did nothing at all.

Keep the records for at least three years after the end of the tax year they relate to: the verification references, the invoices and the evidence behind every materials figure you accepted. The evidence is the part firms skip, and it is the part a compliance visit asks for.

The deduction is not a cost and it is not yours

It is worth being precise about what has happened to the £976, because both parties routinely misdescribe it. It is not a discount, it is not a retention, and it is not a fee. Section 62 treats the sum deducted as paid on account of the subcontractor's own liability to tax and National Insurance — their money, collected early, passing through your account for a matter of weeks. That framing decides every argument about it. A subcontractor who says the deduction has cost them a thousand pounds has confused a date with a number.

How they get it back depends on what they are. A company subcontractor sets the deductions suffered against its own PAYE, National Insurance and CIS liabilities through the Employer Payment Summary in its real-time information filings, and anything still unused is repaid after the end of the tax year. A sole trader or a partner carries the deductions into Self Assessment, where they come off the income tax and Class 4 National Insurance for the year and very often produce a repayment, because 20 per cent of a labour-heavy turnover usually exceeds the liability on the profit that turnover produces. That repayment is the reason a great many subcontractors file early.

For the contractor the practical consequence is a small one that gets forgotten: the deduction is not working capital. It leaves on the 22nd whether or not the client has paid you, and a firm treating the CIS account as a buffer is borrowing from HMRC at a rate it will not enjoy discovering.

When the deduction was wrong

Under-deducting is the expensive error, because the liability sits with the payer. HMRC can recover the amount that should have been deducted from the contractor, not from the subcontractor who received it, and can do so years later. Regulation 9 of the 2005 regulations offers two ways out, and both need a direction from HMRC rather than a decision by you. The first is available where the contractor satisfies HMRC that it took reasonable care to comply with the scheme and the failure was an error made in good faith, or arose from a genuine belief that section 61 did not apply to the payment. The second is available where HMRC is satisfied that the subcontractor was not chargeable on that payment, or has made a return and paid the tax due on it. The first turns entirely on whether you can show the care you took, which is another way of saying it turns on your records.

Over-deducting is the awkward error rather than the costly one. Once the deduction has been paid over and reported, you cannot simply refund it in the next payment run: the sum is in HMRC's hands, the subcontractor's statement says what it says, and the correction route runs through their own return or, for a company, their set-off. Within the same tax year an error can usually be dealt with by amending the return, which is why the check that matters happens before the 19th and not after it. If you catch it on the 20th, tell the subcontractor immediately and put the amendment in — the thing they cannot survive is finding out in July.

The pattern behind almost all of it is the same. Deductions go wrong when the payment is made first and the paperwork is reconstructed afterwards, and they go right when verification, the materials evidence and the rate are settled while the invoice is still an unpaid document. Nothing in the scheme is difficult. All of it is order-dependent.

The regimes next door

The same invoice is usually carrying a second mechanism. The domestic reverse charge in HMRC's VAT Notice 735 applies to supplies of construction services within the scope of the scheme between VAT-registered businesses where the customer is not an end user — which is exactly the position of a contractor paying a subcontractor mid-chain. When it applies, the subcontractor's invoice shows no VAT for you to pay and states that the reverse charge applies; you account for the output tax and recover it in the same return. It has no effect at all on the deduction, which was computed on the VAT-exclusive figure in either case. The interaction between the two is one line of arithmetic and a great deal of confusion, most of it caused by treating the reverse charge as though it changed the amount owed.

Elsewhere the shape recurs with different numbers. The Republic of Ireland runs Relevant Contracts Tax under Chapter 2 of Part 18 of the Taxes Consolidation Act 1997, with rates of nil, 20 and 35 per cent, a contract notification and a payment notification filed through Revenue Online Service before the money moves — closer to the United Kingdom scheme than anything else, and different enough in its mechanics that a firm working both sides of the Irish Sea should not assume a process transfers. In the United States there is no construction-specific withholding, but backup withholding under section 3406 of the Internal Revenue Code requires a payer to withhold at 24 per cent where a payee has not furnished a correct taxpayer identification number on Form W-9, with the payment reported on Form 1099-NEC. Three different regimes, one common design: the obligation, the arithmetic and the liability all belong to whoever is writing the cheque.