21 September 2021
John Harling, principal employment taxes consultant at PSTAX, outlines how important it is to apply the rules correctlyling, principal employment taxes consultant at PSTAX, outlines how important it is to apply the rules correctly
Compliance with the requirements of the construction industry scheme (CIS) remains a complex area for public bodies, most of which are still regarded as ‘deemed contractors’ and, therefore, obliged to operate the scheme. A recent tribunal decision resulted in businesses facing a £1.7 million bill for failing to make deductions due to Her Majesty’s Revenue and Customs (HMRC), highlighting the dangers that can arise.John Harling, principal employment taxes consultant at PSTAX, outlines how important it is to apply the rules correctly
The CIS – basic requirements
Public bodies will be familiar with the CIS and the requirement to operate the scheme in respect of payments made to subcontractors undertaking building and construction work, as defined in relevant legislation and guidance. Those involved in the administration of the scheme will be aware there have been recent changes to the rules affecting public bodies, meaning that some can deregister from the scheme altogether if their expenditure on a rolling twelve-month basis falls below £3 million. We have spoken to several smaller public bodies that can deregister and have sought to do so with HMRC, and they have confirmed this is not always a straightforward process.
However, for most public bodies, the CIS must continue to be operated, and remains a problematic area of compliance for many.
Public bodies operating the scheme must:
determine which construction contracts fall within the scheme
verify with HMRC whether the business they contract with may be paid gross or under deduction
ensure deductions are remitted to HMRC monthly, where net payment is required
make monthly returns to HMRC and subcontractors with payment details.
Areas of difficulty
One area that can prove difficult is following guidance regarding whether work undertaken is considered a construction operation or not. Whilst most types of construction work are included, there are some exceptions, and the rules must be considered each time. The exceptions include:
repairs and maintenance of heating and lighting systems
the services of architects and surveyors
the installation of security systems
the laying of carpets.
Deemed contractors need to consider that where there is a mixed contract (i.e., one that includes some operations within the CIS and others outside), all payments under that contract must be included as being within the scheme.
Another tricky area relates to materials costs where a net payment subcontractor is engaged. The rules mean that payments where a deduction is required must be applied to the labour element and the cost of materials may be excluded. This can sometimes cause difficulties if the subcontractor overstates the cost of materials to reduce the amount from which the deduction is made. Recent changes have tightened the rules to ensure it is only materials costs directly incurred by the subcontractor that may be considered and not those costs incurred further down the chain. The problem remains that costs could still be overstated and deemed contractors must continue to check the position carefully.
The introduction of the domestic reverse charge (DRC) rules regarding value added tax (VAT) have also brought the CIS into sharp focus, as these specific rules only apply where the work being undertaken is within the CIS. Where the DRC rules apply, the customer must self-account for VAT rather than the supplier. The complexities of the DRC rules have meant that public bodies must be aware of what is covered by the CIS, which has led to those within public bodies dealing with these two regimes (often from different teams) working more closely together.
Perhaps the main area where compliance failures occur is in respect of those contractors where a deduction is required but does not actually happen. In a recent First Tier Tribunal decision, two companies – North Point (Pall Mall) Limited and China Town Development Company Limited – failed to make deductions from payments to a subcontractor under a contract, arguing they believed they were not contractors under the scheme. This was based on their understanding of advice from a property agent rather than a tax expert. HMRC determined the scheme should have been operated and deductions made, and this resulted in the companies facing a potential liability of £1.7 million.
The key factor in the tribunal’s ruling was that, although it was agreed the error was made in good faith, the businesses had failed to take reasonable care. This is a crucial aspect of tax compliance and has been the subject of much legal debate and interpretation. Whilst there is no specific definition of the term ‘reasonable care’, HMRC expects appropriate advice be taken, either from a relevant expert or directly from HMRC. Neither applied in this case, leading the tribunal to reach the decision it did.
Whilst the details of this case are complex and specific, they do emphasise the point that mistakes can be made where there is a failure to operate the CIS correctly.
Public bodies should bear in mind there may be other instances where a deduction is due, but not made. This includes cases where it is believed the work being undertaken is not within the definition of a construction operation, or where the public body may not be registered as a deemed contractor when the payment is made. In either scenario, HMRC can recover any withholding that should have been applied (including interest) plus potential penalty charges and will seek to do so if it considers reasonable care has not been taken.
The CIS continues to present challenges in terms of interpretation and administration. As the tribunal case mentioned shows, failure to apply the rules correctly can be costly and could be avoided where proper advice is taken.
Featured in the October 2021 issue of Professional in Payroll, Pensions and Reward. Correct at time of publication.