Where’s The Fairness! “I’ve paid the subcontractor gross and now I have to pay his tax as well?!” is not something that contractors in the construction industry want to hear themselves saying.
This week, Jonathan was musing on whether HMRC have it in for contractors in the construction sector. With the introduction of the VAT Domestic Reverse legislation (see my previous article on ‘WTF! VAT: in Domestic reverse charge on building and construction services situations’) he is now aware of an increase in HMRC enquiries into the operation of the Construction Industry Scheme (“CIS”) rules.
At this point, some of you may think, “So what, nothing bad ever happens on the CIS front so I can safely ignore the CIS rules.”
If you feel that reading this article might be a bit taxing, would you be happy to receive a demand from HMRC of more than £100,000 relating to failures in CIS reporting? This being the amount of the demand that, a few years ago, a new client of ours had just received from HMRC.
I know a demand of this size would have put me off my breakfast, lunch and dinner for a week, which is saying a lot, as you all know how I love my food.
I gathered from the conversation that a client had been listening to their mate down the pub, who explained a cunning wheeze to minimise the tax he deducted from his subcontractors, who always moaned about the amount of tax they were having deducted from their invoices.
When is a plan not a plan?
The wheeze apparently revolved around the subcontractor stating on their invoices that the ‘cost of materials’ was 90% of the invoice value and only 10% related to labour; notwithstanding that this was for a labour only subcontractor.
Like Baldrick’s cunning plan, the outcome, if the plan is followed, can prove very expensive.
So, you might want to prick up your ears and have a quick recap of some of the bare bones of the CIS rules (and the latest HMRC interpretation of the rules) as they relate to the cost of materials:
- Only the cost of materials can be deducted in working out how much tax is deducted from the sub-contractor’s invoice. However, surprisingly, and this is bound to be contentious, the cost of materials cannot include a profit mark up by the subcontractor (this is hardly going to be popular!).
- HMRC have clarified that only materials purchased directly by the subcontractor can be taken into account in working out the CIS deduction. So, if the subcontractor (‘Jo’) has, in turn, used a subcontractor (‘Fred’) any materials on Fred’s invoice cannot be included on Jo’s invoice to his client.
- Only if the subcontractor has hired plant and scaffolding, can these costs be included in the cost of materials (i.e. if the scaffolding is already owned by the subcontractor then any charge in the subcontractors invoice has to be ignored in working out the materials deduction).
At this point in the article, you may be feeling a little queasy; a bit like the healthy young dog who hears he is making a surprise visit to the vets! If so, worry not because a friendly St Bernard accountant could be just around the corner with expertise and a stiff drink but read on!
So what evidence are HMRC looking for to ensure a contractor is applying the CIS rules correctly and what can a contractor do to minimise the risk of digging a hole and falling foul of the CIS rules?
If the subcontractor is claiming for the cost of the hire of plant and scaffolding, HMRC will check how the contractor has ensured that the plant has been hired directly such as:
- Getting the subcontractor to confirm on their invoice that the plant has been hired by them
- Ensuring a copy of the hire agreement is attached to the subcontractor’s invoice as this ensures not only that the plant was hired but also that no profit element is included in the hire charge
- Woof! If the digger on site has the subcontractor details and contact number on it this probably means it is owned not hired. Get a photo in case the subcontractor wants to argue!
HMRC will also check how the contractor has ensured that the cost of materials being claimed is reasonable. For example:
- Is a copy of the subcontractor’s invoice from their builders’ merchant attached to the subcontractor’s invoice?
- Is a copy of the contractor’s merchant price guide attached to the subcontractor’s invoice as evidence of a check for reasonableness?
- Woof! If the day rate for the subcontractor, once the cost of materials is deducted, is below what a labour only subcontractor would want, then it’s a good bet that the cost of materials are inflated.
Although I understand this is fine in theory, I just know contractors are busy people and complying with all these rules is going to be a bit of a fag for them; so, what is the worst that can happen?
“OK Lyra; let’s use your favourite biscuits as an example. If you applied the CIS rules correctly on a subcontractor’s invoice for 200 gravy bones, you would have had to deduct say 30 gravy bones which you would pay to HMRC, leaving you to pay 170 gravy bones to your subcontractor. However, if you incorrectly failed to deduct any gravy bones to pay to HMRC, you would have paid 200 gravy bones to your subcontractor.”
So far, I have worked out that, in either case, I have spent 200 gravy bones, so I do not see the problem.
“The problem, Lyra,” said Jonathan, “is what if those hungry people at HMRC carry out an investigation into your tax affairs and then they ask you for the 30 gravy bones you should have deducted under the CIS rules and then added interest and penalties of say a further 20 gravy bones to their demand and then gave you 30 days to pay them the 50 gravy bones?”
Facing a severe biscuit shortage, I could only say, “But that’s not fair! Surely that can’t be right?”
“Well, we started to act for a small construction client,” Jonathan explained, “who was feeling very hot under the collar as he had been let down by his previous accountant who had not advised him on the CIS rules and reporting requirements. This new client was facing a demand of over £100,000 in penalties, interest and the tax not deducted from their subcontractors; all this on a business that was turning over less than £100,000! And, to end up on a happy note, the client was wagging their tail that we managed to get the payment down to a mere £20,000 and with some time to pay!”
On an even happier note, my nice friends at Xero provide excellent CIS functionality and a CIS gravy bones calculator that enables contractors to keep on top of their CIS reporting requirements, including the online checking of a subcontractor’s CIS payment status and the generation of monthly payment and deduction statements for their subcontractors. Clearly the cat’s whiskers of accounting software!
Need more advice?
If you would like information on how Xero can help you run your business and to avoid the crash diet approach, please get in touch with the lovely team at Rowdens who will be only too pleased to help you.
You can follow us on our Rowdens Facebook page and request to join our Rowdens Facebook Group. We're on LinkedIn too!