A swathe of tax changes in the construction industry has created administrative and compliance challenges for companies, including contractors and sub-contractors.
We discuss the implications and speak to Kevin Winterburn, Director at chartered accountants Sheards, about how they are impacting companies in practice.
Building firms have struggled to comply with the Construction Industry Scheme (CIS), since its introduction in April 2021, despite a strong awareness campaign. The CIS makes sure construction firms pay the right tax by requiring contractors to deduct tax at source, from their subcontractors’ pay, through a similar system to pay as you earn (PAYE).
The scheme has been an administrative headache for contractors because the rules require them to: register for CIS, verify relevant subcontractors with HMRC, make the deductions and record the details. Contractors must also then make the net payment to the subcontractor, give them a statement of deduction and pay it to HMRC. Subcontractors must also register for the CIS or have deductions taken at 30% rather than 20%.
This administrative effort can be complex and onerous for many contractors, especially small companies and those facing other challenging issues related to the Covid-19 pandemic and Brexit.
HMRC’s power to override
Winterburn says the biggest challenge many companies face comes from HMRC’s power to amend and override contractors’ submissions on CIS deductions. “An example is a worker that has suffered some CIS deductions, but HMRC have no record of those deductions because his client has not been doing their submissions correctly, or at all,” he said.
“His internal paperwork shows the deductions, but he has no deduction statement from his client. HMRC needs the two records to agree – if they do not, they may use their new powers to override and cancel the claim. The worker needs to get his client to send that statement; and construction firms need more robust record-keeping systems.”
The VAT reverse charge
Another significant tax change is the VAT reverse charge. This could have a major impact on businesses involved in buying and selling certain construction services reported under CIS. The charge, which came into force in March 2021, stops subcontractors charging VAT to contractors, then disappearing before paying it to HMRC – known as missing trader fraud. The charge shifts the liability for accounting for output VAT from the supplier (subcontractor) to the customer (main contractor). The government says it will save more than £495 million in tax revenues by 2024.
Kevin says: “The VAT changes created an education burden in understanding the new rules, and administrative challenges in changing invoicing practices. Any company in the construction industry could be affected depending on where they are in the chain.
“When invoicing customers, they need to understand whether they should or should not charge VAT on their invoices. For example, they need to understand from the customer what the work is for, the end use of the building, and where they are in a contractual chain. Crucially, the companies involved need to be on the front foot, not accepting supplier invoices at face value, but understanding for themselves when VAT should apply.”
The off-payroll working rules, also known as IR35, apply to contractors who work through an intermediary, such as a limited company, but would be an employee if they provided their services directly to their client. It avoids such workers paying less income tax and national insurance than employees.
From April 2021, medium and large private companies became responsible for deciding if IR35 applies to their contractors. This change has had a huge impact because of the complexity of many contractual chains in construction, making it hard to figure out who decides employment status and who has the tax and national insurance liability under IR35 rules.
Despite attempts to raise awareness, many companies still seem unprepared for this change, creating much uncertainty in the labour market. This, in turn, risks strangling contractor opportunities as they may instead look to do more work using internal employees.
However, not everyone in construction is aware that IR35 ‘trumps’ CIS and that workers deemed to be ‘within’ IR35 become treated like employees and go onto PAYE — CIS no longer applies. “As IR35 trumps your CIS position, you need to think about IR35 first,” explains Kevin. “An example is a contractor working for a company, invoicing every week and deducting CIS. But leading up to April, the company notified him he was within IR35. He moved off CIS and is now treated as an employee for tax purposes. But he then negotiated a higher rate with his client as it’s less tax efficient to be on IR35. Many such workers will be charging higher rates. The shortage of construction labour, especially post-Brexit, put them in a position to do that. So, this is increasing costs for construction businesses.”
It remains to be seen how many of these factors will play out. But for now, firms need to focus carefully on compliance to ensure they avoid any issues with HMRC and consider insurance to cover all eventualities.