Advice for subcontractors in construction

You have recently started out as a subcontractor in the construction industry. But were surprised to find that out you had tax deducted from your first payment. Is gross payment status is worth applying for? Tax partner Kenny Adamson, explains the position.

Construction industry scheme
The construction industry scheme (CIS) applies to most construction work. The scheme dictates how payments made by contractors to subcontractors should be made, when tax must be deducted (and at what rate) and paid over to HMRC. Contractors must register with HMRC and verify the tax status of subcontractors that they engage. They must also make monthly returns online to HMRC detailing all payments made to subcontractors in the previous month.

Subcontractors can also register with HMRC. If they fail to register, they will suffer a higher rate of deduction on payments made to them by a contactor. They can also apply for gross payment status.

Payments to subcontractors
If a subcontractor is registered with HMRC but does not have gross payment status, the contractor must deduct 20% from payments that they make to the subcontractor and pay it over to HMRC. This is known as “net payment status”. If the subcontractor is not registered with HMRC for the scheme, a higher deduction rate applies, and the contractor must deduct 30% from payments made to the contractor and pass this over to HMRC.

The amounts deducted from the payments and passed over to HMRC count towards the subcontractor’s tax and NI bill and are reconciled via the tax return. If you pass certain tests and successfully apply for gross payment status, the contractor can make payments to the subcontractor without deducting tax.

Please note, a subcontractor’s tax status does not affect the overall amount of tax and NI that they pay, simply how and when the payments are made.

Advantages of registering for CIS
By registering for the construction industry scheme, the subcontractor can avoid having 30% deducted from their payments. Even if they do not qualify for gross payment status, registering will reduce the deduction rate to 20%. This is clearly advantageous from a cash-flow perspective.

You can register for the CIS online. The information that you will need to provide will depend on whether you as a subcontractor are registering as an individual, the owner of a company or as a partner in a partnership. Subcontractors who are unable to register online can register by post. Those who are based abroad but who do work in the UK should still register for the scheme.
We would advise you to register for the CIS, this is worth the effort as it reduces the deduction made by the contractor.

Gross payment status
If you want the contractor to make the payments without making a deduction on account of tax, you will need to secure gross payment status. To qualify you will need to pass various tests and demonstrate that:

• You have paid your tax and NI on time in the past.
• Your business undertakes construction work, or that you provide labour for construction work in the UK.
• You have a bank account for your business.

You are initially granted net payment status on registering. Gross payment status is only conferred after successful completion of three tests, the turnover test, the business test and the compliance test.

The turnover test
You need a minimum level of turnover to qualify for gross payment status. The minimum amount depends on whether the subcontractor is an individual, in partnership or in a company.
Under the standard test, you must have net construction turnover equal to or exceeding the following thresholds in the twelve months preceding the date of the application:

Individuals – £30,000.
Partnerships – £30,000 per individual partner. Where the partnership has one or more corporate members, for each corporate partner, the figure of £30,000 is multiplied by the number of relevant persons associated with that company.
Companies – £30,000 multiplied by the number of persons who are relevant persons in relation to a company.

As regards a company or corporate partner, relevant persons are the directors and, where the company is a close company, any beneficial owners of shares. An individual is only counted once if they are both a director and a beneficial owner of shares.

Although most applicants will apply on the basis of turnover earned by the business in its own right, the test can be passed on the basis of inherited receipts or transferred receipts.

You should check your turnover before proceeding with an application for gross payment status. If the turnover is too low there is no point in applying. You will need to wait until they have the turnover required.

The business test
To pass the business test, you must be able to demonstrate that you are carrying out construction work in the UK or providing labour for such construction work. You must also show that you run your business through a bank account in the UK. HMRC will check the application to ensure that these tests are met and will verify the bank account details provided.

The compliance test
To meet the compliance test, in the twelve months prior to the date of the application, you must have:

• Completed and returned all tax returns that were sent to you.
• Supplied any information requested in relation to your tax affairs.
• Paid all tax due personally or by your business by the due date.
• Paid your personal NI contributions by the due date.
• Paid any PAYE and NI contributions due as an employer by the due date.
• Paid any deductions due as a contractor under the CIS by the due date.

In assessing whether you have passed the compliance test, in the same twelve-month period, HMRC will disregard three late submissions of the contractor’s monthly return under the CIS up to 28 days late, three late payments of PAYE, NI or CIS deductions up to 14 days late, any late end of year employer return, one late payment of self-assessment tax up to 28 days late.

Subcontractor clients who pass all three tests can apply for gross payment status online or by post. Applying will also register the subcontractor for the CIS if they are not already registered.

Potential downsides
Gross payment status is advantageous from a cashflow perspective as you will receive the full amount of the payment. However, as the status does not affect the tax and NI due, you must be disciplined enough to put money aside to meet your future tax bills. While this provides the opportunity to benefit from interest on the money put aside, you may prefer for deductions to be made from your payments. Even where deduction is made at source, there may still be some tax and NI to pay, particularly if you pay tax at the higher rate.

IN SUMMARY
While gross payment status allows eligible subcontractors to receive payments without deduction, provided the turnover, business and compliance tests are met, it is not be the best option for all subcontractors. You may prefer or be better suited to having money deducted to set against your future tax bills.

We would advise you to register for the CIS, this is worth the effort as it reduces the deduction made by the contractor. By registering for the construction industry scheme, the subcontractor can avoid having 30% deducted from their payments. Even if you do not qualify for gross payment status, registering will reduce the deduction rate to 20%. This is clearly advantageous from a cash-flow perspective.

Contact the JRW Hogg & Thorburn team to discuss this further and any other related questions you may have.