CIS tax explained for the lad with one or two subbies

A mate of mine took on his first subbie last spring. Decent sparky, turned up on time, did a clean job on a two-bed extension. At the end of the month my mate paid the invoice in full, the lot, labour and materials, nothing taken off. Felt like the fair thing to do.

Three months later HMRC sent a letter asking where the CIS deductions were. Turned out he owed them himself, out of his own pocket, because he hadn't taken them off at source. About £1,400 he had to find from nowhere. He wasn't dodging anything. He just didn't know the scheme caught him the second he paid another trade to do construction work.

This is CIS in plain English. Who it catches, what you take off, the deadlines that bite, and how the subbie gets the money back so nobody's actually out of pocket when it's done right.

What CIS actually is, and who it catches

CIS stands for the Construction Industry Scheme. The idea is simple. When a contractor pays a subcontractor for construction work, the contractor holds back a slice of the payment and sends it straight to HMRC. That slice counts as an advance on the subcontractor's Income Tax and National Insurance for the year.

It isn't a separate tax and it isn't a punishment. It's the subbie's own tax, collected early, because HMRC learned a long time ago that money moving around building sites in cash had a habit of never reaching a tax return.

Here's the part that catches people. You're a contractor under CIS if you pay subcontractors to do construction work. That's it. You don't need a yard, a fleet, or ten lads. If you're a sole trader who takes on one self-employed sparky for a fortnight, you're a contractor for CIS purposes and the rules apply to you in full.

There's a second way in, called a deemed contractor. If your business isn't really in construction but you spend an average of more than £3 million a year on construction work over a rolling 12-month period, you're pulled into the scheme too. Most trade firms reading this are caught by the first route, not the second.

CIS covers most construction work to a permanent or temporary building: groundwork, bricklaying, roofing, plastering, decorating, installing heating and lighting, demolition. A handful of things sit outside it, like carpet fitting, scaffolding hire with no labour, and professional work such as architecture and surveying. If you're not sure whether a job is in or out, the guidance on gov.uk lists the exact trades included and excluded.

The two hats: contractor and subcontractor

Plenty of trades wear both hats at once, and that's where the confusion starts.

You're a contractor when you pay someone else to do construction work for you. You have to register as a contractor with HMRC before you make that first payment.

You're a subcontractor when you do construction work for another business and they pay you. You should register as a subcontractor so you get the 20% rate instead of 30%.

Say you're a builder running a small firm. You invoice a main contractor for your work, so to them you're a subcontractor and they deduct CIS from what they pay you. But you also pay a plasterer and a labourer of your own, so to them you're a contractor and you deduct CIS from what you pay them. Both hats, same week. You register for both sides, and you run the contractor side properly because that's the side HMRC chases.

The three deduction rates: 20%, 30%, 0%

There are only three numbers to remember.

• 20% is the standard rate. You use it when the subbie is registered for CIS and verifies successfully with HMRC.
• 30% is the higher rate. You use it when the subbie isn't registered, or you can't verify them. The extra 10% is the price of HMRC not being sure who they're dealing with.
• 0% applies when the subbie holds gross payment status. You pay them the full amount and deduct nothing. They settle all their tax themselves at the year end.

The rate is set per subbie, not per job, and HMRC tells you which one to use when you verify them. You don't guess.

What you deduct from: labour only

This is the single most common mistake, the one that costs real money, so it gets its own worked example.

You apply the percentage to the labour part of the invoice only. Before you work out the deduction, you strip out the bits that don't count:

• The cost of materials the subbie actually paid for
• VAT charged on the invoice
• Plant hire that meets HMRC's conditions
• The CITB levy, if it applies

Whatever's left is the labour, and that's what you take the 20% or 30% off.

Worked example

Your registered subbie, on the 20% rate, sends you this invoice for a week's work:

• Labour: £1,800
• Materials he bought: £700
• Invoice total (net): £2,500

You work out the deduction on the labour, not the total:

• 20% of £1,800 labour = £360 deducted
• You pay the subbie: £2,500 minus £360 = £2,140
• You send HMRC the £360 by the 22nd of the following month

Now look at what my mate did. He deducted nothing, paid the full £2,500, and HMRC still wanted their £360 (and more, across several months). Worse, if you get the maths wrong by deducting on the whole £2,500 instead of just the labour, you've shorted your subbie by £140 on the materials he already paid for out of his own pocket. Get the split right and everyone's square.

Verifying a subbie before you pay a penny

Before the first payment, you verify the subcontractor with HMRC. You can do it through your HMRC online account or your accounting software. You'll need the subbie's name, their Unique Taxpayer Reference, and their National Insurance number or company registration number.

HMRC checks them and hands back a verification number plus the rate to use, 20%, 30%, or 0%. That number is your proof you did it properly. Keep it.

Skipping verification is where contractors get stung. If you pay a subbie at 20% without verifying and it turns out they should have been on 30%, HMRC can come after you for the shortfall, not the subbie. You did the deducting, so you carry the can. A two-minute check up front saves a nasty letter later.

The monthly return, the deadlines, the penalties

Every month you tell HMRC who you paid and what you deducted. This is the CIS monthly return, and the dates are fixed.

The tax month runs from the 6th to the 5th. Your return for that month is due by the 19th. The deductions you've held back get paid to HMRC by the 22nd if you pay electronically, which almost everyone does.

You also have to give each subbie a payment and deduction statement within 14 days of the end of the tax month. That's their receipt for the tax you've taken off, and it's the document they use to claim it back. No statement, and your subbie can't prove what was deducted, which makes you the unpopular contractor.

The late filing penalties are automatic and they stack up fast:

• 1 day late: £100
• 2 months late: another £200
• 6 months late: a further £300 or 5% of the deductions, whichever is higher
• 12 months late: another £300 or 5%, whichever is higher, and it can climb further in serious cases

Note the trigger. The £100 lands for being one day late on the return, even if you owe nothing that month. If you had no subbies to pay in a given month, you either file a nil return or tell HMRC you'll have no returns to make for a while. Silence is what gets penalised.

Gross payment status, and how the subbie gets the money back

Some subcontractors hold gross payment status, which means you pay them the full invoice with nothing deducted. They then settle their whole tax bill themselves at the year end. To qualify, a subbie has to pass three HMRC tests: a business test (the work is run as a proper construction business with a UK bank account), a turnover test (broadly £30,000 of labour-only turnover per partner or director, or £100,000 for a larger business), and a compliance test (tax returns and payments filed on time). It's worth having for cashflow, because nothing gets held back, but HMRC reviews it and can pull it if the firm slips on its own deadlines.

For everyone else, the deducted money isn't lost, it's parked. How the subbie reclaims it depends on how they trade:

• Sole traders put their CIS deductions on their Self Assessment return. The total deducted across the year is offset against the Income Tax and National Insurance they owe. If more was deducted than they actually owe, which is common, HMRC refunds the difference.
• Limited companies offset CIS deductions taken from them against their own PAYE and CIS bill through the payroll system each month, or claim a repayment after the tax year closes.

This is the bit that calms a nervous subbie down. The 20% isn't a tax on top. It's their normal tax, paid in instalments through the year instead of one lump at the end. Plenty of subbies end up with a refund because the flat 20% deducted more than their final bill once expenses and the personal allowance are counted.

What NOT to do (5 common mistakes)

1. Don't deduct on the whole invoice. Materials, VAT and qualifying plant hire come off first. Deduct on labour only. Get this wrong and you either short your subbie or short HMRC, and both come back to bite you.
2. Don't pay a new subbie before verifying them. If you guess the rate and it's wrong, HMRC chases you for the shortfall, not them. Verify, get the number, keep it.
3. Don't skip the monthly return in a quiet month. The £100 penalty is for filing late, not for owing money. File a nil return or tell HMRC you've paused. Don't go quiet.
4. Don't treat a regular worker as a subbie just to dodge the admin. If someone works set hours under your control with your tools, HMRC may decide they're really an employee. That's false self-employment, and it lands you with back PAYE, National Insurance and penalties. When in doubt, check the employment status before you set the arrangement.
5. Don't bin the paperwork. Verification numbers, payment and deduction statements, the monthly returns. Keep them for at least three years. When HMRC asks, and on CIS they do ask, the contractor who can produce the records walks away clean.

The habit that keeps CIS boring

The trades who never have a CIS scare all do the same dull thing. They run it on a fixed monthly rhythm instead of a panic on the 18th.

The day a subbie's invoice comes in, split it then and there: labour here, materials there, VAT separate. Log the deduction against the labour line straight away. Come the tax month end, the return is just a case of reading off numbers you already recorded, not digging through a glovebox of crumpled invoices trying to remember what was materials and what was labour.

That's the whole game. An invoice that separates labour from materials cleanly, recorded the day it lands, turns the monthly return into a five-minute job. TradeStash splits labour and materials on every invoice and keeps the running total per subbie, so when the 19th comes round the figure's already sitting there. Boring is exactly what you want from CIS. Boring means no letter from HMRC.