The Construction Industry Scheme (the CIS) is a mandatory tax deduction scheme that obliges contractors to deduct tax from payments made to subcontractors under construction contracts. When we give 'contractor', 'subcontractor' and 'construction contract' their ordinary meaning, it is not immediately obvious how the CIS could impact tenants whose business is not in the construction industry.
However, the CIS defines these terms much more widely – a contractor is simply someone who pays for construction services and a subcontractor is someone who provides them for payment. If a landlord is paying a tenant for construction services, the CIS could apply resulting in a substantial deduction from that payment. The good news is that, in most cases, the impact of any cashflow implications for the tenant can often be reduced or eliminated with early consideration and action.
Why does the CIS matter to tenants?
Consider this scenario:
The tenant has entered into an agreement for lease with its landlord. Under the agreement, the tenant has an obligation to carry out works to the leased property. These works include tenant fit-out works and works to the shared areas of the building. The landlord will pay a contribution of £1 million towards the works.
The landlord has confirmed that it is a CIS contractor. The tenant, who is obliged to undertake works under the agreement, is therefore a CIS subcontractor.
The tenant has never considered the CIS before and is not registered with HMRC as a CIS subcontractor. This means that the landlord must deduct 30% from the payment to the tenant. The tenant, who was expecting £1 million, only receives a cash payment of £700,000. The landlord pays the remaining £300,000 to HMRC.
The tenant has to pay £1 million to the construction company undertaking the works. The construction company is registered under the CIS for gross payment so the tenant has to hand over £1 million, £300,000 more than it has received from the landlord. The tenant, in this scenario, can set the tax deducted against its PAYE and NIC liabilities, but may have to wait until it makes its corporation tax payment before it can fully recover the tax deducted.
When will the CIS apply?
The CIS should always be considered whenever a tenant enters into an agreement for lease (or other contract with the landlord) under which the tenant has an obligation to undertake works and the landlord has an obligation to make payment to the tenant.
The CIS will apply to payments made by the landlord if:
- the landlord is a CIS contractor. The definition of CIS contractor includes not just mainstream contractors which carry on a construction business. It also includes "deemed contractors" - businesses that do not operate a construction business but whose average spend on relevant construction works is more than £1 million a year on average in any three-year period. It also includes public bodies such as housing associations and local authorities, again by reference to their average spend.
- the payments made by the landlord do not qualify for exemption. Payments will be exempt if they are a reverse premium – which for CIS purposes, means they are a pure inducement in respect of CAT B (tenant fit-out) works only. If the tenant is undertaking CAT A works (i.e. works that are usually the responsibility of the landlord such as structural works, flooring, lighting or works to common areas) instead of, or as well as, tenant fit-out works, all payments made by the landlord under the same contract will be caught by the CIS.
What is the impact for tenants?
If payments by the landlord are caught by the CIS, the landlord must make deductions from the payment. The amount of the deduction depends on the registered status of the tenant.
- If the tenant is not registered with HMRC under the CIS as a subcontractor, the deduction will be 30%. For a £1 million payment (as in our scenario above), that is £300,000.
- If the tenant is registered with HMRC for payment under deduction, the deduction will be 20%. For a £1 million payment, that is £200,000.
- If, unusually, the tenant is registered with HMRC as a subcontractor with gross payment status, payments will not be subject to deduction.
The tax that is deducted will be paid to HMRC by the landlord and is treated as an advance payment of the tenant's PAYE and NIC liability or its corporation tax bill.
It therefore does not represent an absolute cost for the tenant, however it can still cause cash flow problems, particularly if the deduction is large and the PAYE and NIC liability of the tenant is relatively small. The tenant may need to wait until it pays corporation tax to fully offset the amount deducted.
What can a tenant do to ease the cashflow problem?
The first thing all tenants subject to a potential CIS deduction should do is register with HMRC as a subcontractor for payment under deduction. This is a quick and straightforward process which can be done online or by telephone and immediately results in the deduction from payments being reduced from 30% to 20%.
A tenant might also consider applying for gross payment status if they meet the conditions. This is a much more involved exercise, and for tenants without any history operating within the construction industry, there is no guarantee that HMRC will accept the application. The registration process can also take several weeks. One situation where tenants might carefully consider this is when payments by the landlord are in excess of £3 million as that might allow the gross payment conditions to be met.
Another way to mitigate the cashflow consequences of the CIS is to separate payments which would otherwise be exempt (such as reverse premiums) and the works to which those payments relate into a separate contract.
Could the tenant also be a CIS contractor?
In addition to being a CIS subcontractor in respect of payments by the landlord to the tenant, the tenant could also be a CIS contractor in relation to payments it makes to someone else to carry out the construction works.
To the extent these payments relate to property which the tenant, or a group company, will use for the purpose of its business, these payments will be exempt from the CIS. This will apply in the majority of cases and should mean that the tenant does not have to register, though the position needs to be checked carefully. This exemption does not apply to landlords.
How we can help
We can help guide tenants (and landlords) through the complexities of the CIS.
In particular, we can help determine whether payments made by a landlord to a tenant will be caught by the CIS, help tenants assess the potential impact of any deduction and advise how to mitigate or eliminate this risk. As with all tax issues, the earlier the CIS is considered the more chance there is of reducing cash flow implications for the tenant.