Lee Sharpe warns that the taxman believes the ‘construction industry scheme’ has a longer reach than you might think.
Introduction
The construction industry scheme (CIS) is universally acknowledged as a pain – whether you are a contractor having to deal with additional paperwork and returns to HM Revenue & Customs (HMRC), or a sub-contractor having to wait for months for a rebate of your own money. This article aims to set out the key points to consider if you are in the habit of developing – or even improving – properties.
Who is a property developer?
You might be forgiven for thinking that you know the answer to that question since it is (almost) universally accepted that a property developer is someone who develops land for profit (the clue’s in the name!). As a general rule, a property developer is a trading business, buying, ‘doing up’ and selling on. By contrast, a property investor generally buys to let out, and this is normally considered an investment, not a trading activity.
So, if you acquire property for investment purposes, you won’t be considered a property developer, right? After all, renting property out afterwards is a passive investment activity, and a fairly good indicator that you will not get the benefit of trading status for losses, capital gains tax entrepreneurs’ relief and the like.
In fact, HMRC’s own guidance on CIS seems at first to agree. The Construction Industry Scheme Reform (CISR) manual says (at CISR12080):
”A 'property investment business' is not the same thing as a 'property developer'. A property investment business acquires and disposes of buildings for capital gain or uses the buildings for rental.“
Construction operations and deemed contractors
Unfortunately, it doesn’t end there. Even where you are predominantly a property investor, if you spend more than £1 million a year, on average, on ‘construction operations’, then you will be caught as a deemed contractor for CIS purposes. The definition of ‘construction operations’ is set out in the tax legislation (FA 2004, s 74). It is widely drawn, and includes as a starting point the construction, alteration, repair, extension, demolition or dismantling of buildings and/or works. There are numerous exceptions, however – more on this later.
Tax Trap :
Construction operations...full stop
While many property investors can say with some confidence that they won’t spend more than £1 million a year on repairs, renovations, and the like, HMRC has recently snuck in an interesting further trap for property investors. Following an update in July 2012, CISR12080 now goes on to say:
”Where a business that is ordinarily a property investor, undertakes activities attributed to those of ‘property development’, they will be considered a mainstream contractor [caught for CIS] during the period of that development.”
So basically, when a property investor decides to undertake a building project – say to develop a property, even for rental – HMRC will suddenly consider him (or it) to be a property developer, and therefore caught by CIS as a contractor. Makes you wonder why they bothered with a £1 million threshold, doesn’t it?
It also appears to fly in the face of guidance issued less than a year earlier specifically for deemed contractors, which said:
“Note: Property investors will only be brought into CIS where their expenditure on construction operations exceeds £1 million per annum.”(HMRC’s ‘News for Construction Industry Scheme – Mainstream and Deemed Contractors; 31 August 2011).
So what if CIS applies?
There are two reasons why getting caught up in the CIS is such a problem for property businesses; it involves substantial administration work, and there is also a harsh penalty regime for failing to comply.
CIS administration for contractors
The CIS regime is effectively a simplified version of PAYE: as the contractor, a property developer has to:
- set up a PAYE scheme, if one doesn’t already exist;
- register with HMRC for CIS as a contractor;
- before paying someone for doing construction work, verify that sub-contractor with HMRC, to see if any tax should be withheld from those payments;
- with-hold taxes from payments to a sub-contractor, where instructed to do so by HMRC. Some sub-contractors are entitled to be paid without any tax deduction but others must have 20% tax withheld – sometimes more;
- consider whether or not any sub-contractors should more properly be considered employees and if so apply PAYE and NICs (including employers’ NICs) instead;
- provide the sub-contractor with a statement of deduction, covering payments made;
- make monthly online returns to HMRC of all payments made to sub-contractors, tax withheld, etc.; and
- pay over to HMRC any CIS tax withheld – usually monthly.
Tax Trap :
CIS penalties
The penalty regime for late returns is particularly onerous. A contractor basically has two weeks from the end of the tax month to submit the monthly CIS return. Note that a ‘nil’ return is still required even if no relevant payments were made in the tax month.
Penalties are as follows:
- return is a day late - £100 even if no sub-contractors were paid and no tax is due;
- return is two months late – a further £200, even if a ‘nil’ return;
- return is 6 months late – another £300 or 5% of the tax due on the return, if higher; and
- return is 12 months late – a further £300 or 5% of the tax due – more if HMRC thinks that the return has been deliberately held back.
Note that this regime applies to each monthly return. A monthly return more than 12 months overdue will cost £900, even if there is no tax due and no sub-contractors were paid!
CIS penalties – the ‘bright side’
Incredibly, the current penalty regime is generally considered to be an improvement on the previous regime: it was possible to rack up penalties of almost £100,000 with no actual tax liability – I once helped a contractor who owed around £5,000 in CIS tax, but whom HMRC wanted to charge almost £70,000 in penalties.
Under the current regime, if you have never filed CIS returns before and HMRC determines that you should have been making returns then the penalties should be capped at no more than £3,000 – plus tax-geared penalties, if any.
HMRC is NOT always right!
I mentioned that there are numerous exceptions to the ‘construction operations’ for CIS. These tend to be quite specific – such as architects’ fees. I once advised a specialist engineering company which had run up more than £30,000 in penalties. But their work oriented around fire protection and security systems which are specifically excluded (by FA 2004 s 74(3)). The penalties were reduced to nil when HMRC finally accepted that the exclusions over-ride the previous section which defines construction activities for CIS – although you wouldn’t know it from reading CISR14290 ‘Security Systems’, last updated in December 2013.
CIS – Am I caught?
Clearly, anyone who is developing property for re-sale is likely to be caught by the CIS regime. Property investors with large portfolios who spend £1 million a year or more on maintenance and improvements are likely also to be ‘deemed’ contractors and subject to CIS.
The more difficult area is where a property investor is contemplating a ‘build’, renovation or conversion project, even where the property will be let afterwards; ask HMRC’s CIS officers and they will usually argue that CIS applies, at least for the duration of the project.
Practical Tip :
Remember that substantial penalties arise for failing to submit CIS returns, even if you don’t have to pay any tax over to HMRC. If you are concerned that you may fall within its scope, speak to an adviser who is experienced in the CIS regime, or directly to HMRC – but note it is quite rare for them to accept that a building project is not caught. It also makes sense to close down the scheme as soon as possible, once the project has finished.
