Category: Construction

Do Property Flippers and Investors need to do CIS?

two man holding white paper

What is CIS?

The Construction Industry Scheme (CIS) applies to anyone who carries out construction work as a trade, in other words developers, contractors, building maintenance and repairs, decorating, property conversion, basically if you use sub-contractors to work on a building its probably within CIS. It does, however, exclude property investors and domestic householders.

Under CIS the Contractor/Developer has to use the subcontractors UTR, NI and other details to verify the subcontractor with HMRC, this determines in a deduction that need to be taken and paid to HMRC.

The Construction Industry Scheme (CIS) deduction rates are:

  • 20% for registered subcontractors
  • 30% for unregistered subcontractors
  • 0% if the subcontractor has ‘gross payment’ status – for example they do not have deductions made

The Contractor/Developer must pay these deductions to HMRC – they count as advance payments towards the subcontractor’s tax and National Insurance bill.

The contractors then does a monthly return for HMRC, makes payment of the tax collected and issues a deduction statement to the subcontractor.

Flipping and Developing

Flipping is where a property is purchased and work carried out to resell for a profit, this is a development activity and within CIS.

Property developers are included within the meaning of mainstream contractors because their business activity is the creation of new buildings, or the renovation or conversion of existing buildings, or other civil engineering works. The same is true of a speculative builder.

CISR12080 – The Scheme: contractors: property developers and property investment businesses – HMRC internal manual – GOV.UK (www.gov.uk)

This not covered by …

Contractors may be construction companies and building firms, but may also be government departments, local authorities and many other businesses that are normally known in the industry as ‘clients’.

Some businesses or other concerns are counted as contractors if they have spent more than £3 million on construction within the previous 12 month period. The rules require a business to monitor construction spend regularly.

Private householders are not counted as contractors so are not covered by the scheme.

Construction Industry Scheme: a guide for contractors and subcontractors (CIS 340) – GOV.UK (www.gov.uk)

This no lower limit for CIS, if you are a developer/contractor you have to do CIS.

When do Investors need to do CIS?

As noted above there is the £3m rule but also where the work is substantial it could be within CIS. See example below..

The property investment business acquires a large, dilapidated building to add to its portfolio, and decides to convert the building into a series of flats which it will then individually let out. As a result, substantial development is required to the property to change the building to its new use. In respect of this type of development we would regard the property investment business as having taken on the mantle of a mainstream contractor as its business activity is now that of construction operations.

Where, at a future date, the investment business reverts to property investment activities only, then their status as a deemed contractor should be applicable once again. If their expenditure is likely to remain below £3 million on a rolling 12-month period, then deregistration from CIS may be considered appropriate.

CISR12080 – The Scheme: contractors: property developers and property investment businesses – HMRC internal manual – GOV.UK (www.gov.uk)

Gross Status

Clearly subcontractors aren’t enthusiastic about CIS as impacts their cashflow, they get the money back as its offset against their tax liability, but even so, its not ideal.

However, its relatively easy to get Gross Status, to qualify..

You must show HM Revenue and Customs (HMRC) that your business passes some tests. You’ll need to show that:

  • you’ve paid your tax and National Insurance on time in the past
  • your business does construction work (or provides labour for it) in the UK
  • your business is run through a bank account

HMRC will look at your turnover for the last 12 months. Ignoring VAT and the cost of materials, your turnover must be at least:

  • £30,000 if you’re a sole trader
  • £30,000 for each partner in a partnership, or at least £100,000 for the whole partnership
  • £30,000 for each director of a company, or at least £100,000 for the whole company

If your company’s controlled by 5 people or fewer, you must have an annual turnover of £30,000 for each of them.

What you must do as a Construction Industry Scheme (CIS) subcontractor: How to get gross payment status – GOV.UK (www.gov.uk)

Contact Us for more help

steve@bicknells.net

Why Builders and Contractors need to do Cost Value Reconciliation?

Cost Value Reconciliation and Cost Value Comparisons are used on construction projects, they are essential if you want to keep project on budget and report costs and revenue correctly.

The CVR not only looks at costs to date and sales revenue to date but also brings in committed costs, forecasts, contingencies, scope changes, stage of completion and forecasts.

There are two types of Revenue Valuation, Internal (for use with the CVR) and External (application for payment), what gets certified with the client is unlikely to be the true internal value. There may also be items disputed with the client.

The CVR then results in adjustments to both Revenue and Costs to give a true reflection of Profitability.

Costs should not be under estimated and Revenue should not be over estimated within the CVR.

The CVR is great tool to highlight spend issues early on and take action with the client to keep within budget.

Here is an example CVR from the Template Store Cost report template (online-templatestore.com)

The case of Mark Smith v HMRC [2012] TC02321

The appellant in this case was trading as a builder who provided ground works for construction companies. He had an in house surveyor who produced his applications for payment, the clients surveyor certified the valuation within 3 weeks and the accountant recognised the value when certified. The contracts were fixed price and lasted up to 12 months, The business started as a Sole Trader and was subsequently incorporated.

HMRC opened an enquiry in 2001/2002.

The central issue before the tribunal related to the appellant’s computation of profits. It was admitted that his accounts understated the profits gained in a particular tax year. However, it was his contention that this was a “one-off”.

The tribunal held that HMRC’s assessments were in fact justified.

The reason why HMRC were successful was that in the case of Mark Smith he based his income on certified revenue, this meant that the profit was understated, within Construction “UK GAAP” requires revenue to be reported on application based on the CVR matching approach.

The details of the additional profits and tax for each year are as follows:

(1)2000/01: additional profits of £43,189 giving rise to tax of £17,275.60

(2)2001/02: additional profits of £65,205 giving rise to tax of £24,972.02

(3)2002/03: additional profits of £73,889 giving rise to tax of £27,737.86

(4)2003/04:additional profits of £70,023 giving rise to tax of £27,503.41

(5)2004/05: additional profits of £70,000 giving rise to tax of 27,704.18

(6)2005/06: additional profits of £65,240 giving rise to tax of £26,735.44

(7)2006/07: additional profits of £45,541 giving rise to tax of £18,671.81

Further guidance is in UITF40 which came in 2005 and basically stated revenue should be reported in line with work completed by the seller.

Under the principle of matching costs and revenue should be aligned.

steve@bicknells.net

How to offset Construction Industry Scheme deductions – CIS Offsetting (CIS340 4.13)

If you have suffered deductions from your income its generally reclaimed

  1. The Self Employed enter the CIS suffered on their self assessment return, its then part of their tax calculation
  2. Companies reclaim via their Payroll – Companies can also offset

Construction Industry Scheme: a guide for contractors and subcontractors (CIS 340) – GOV.UK (www.gov.uk) – Section 4.13

Companies that have deductions taken from their income as subcontractors should set-off these deductions against the amounts payable monthly or quarterly for PAYE, National Insurance contributions and Student Loan repayments due from their employees and CIS deductions from their subcontractors. This should be done monthly (or quarterly, as appropriate) and the calculation should be shown on the company’s EPS.

Companies should simply reduce the amount of PAYE, National Insurance contributions, Student Loan repayments and any scheme deductions they pay over to our accounts office by the amount of CIS deductions made from their income.

https://youtu.be/bx4D-UmhfEg

CIS132 – Construction Industry Scheme (publishing.service.gov.uk)

The CIS132 is used to keep a record of the offsets, you could create a spreadsheet to keep these records.

Steve@bicknells.net

What counts as Labour under CIS (Construction Industry Scheme)?

Under the Construction Industry Scheme (CIS) if you use subcontractors who don’t have Gross Status the contractor has to make a deduction of 20% or 30% and pay it to HMRC.

In the CIS340 guidance, the deduction is applied as follows

There are 2 steps that contractors must follow.

Step 1: Work out the gross amount from which a deduction will be made by excluding VAT charged by the subcontractor if the subcontractor is registered for VAT, read the examples in CIS 340 Appendix D.

The contractor will need to keep a record of the gross payment amounts so that they can enter these on their monthly returns.

Step 2: Deduct from the gross payment the amount the subcontractor actually paid for the following items used in the construction operations, including VAT paid if the subcontractor is not registered for VAT:

  • materials
  • consumable stores
  • fuel (except fuel for travelling)
  • plant hire
  • the cost of manufacture or prefabrication of materials

The bit that is left after following the steps above is the Labour to which tax deduction of 20% or 30% is applied.

What is the Labour if the subcontractor has its own subcontractors?

The subcontractor needs to show the amount of labour inclusive of the subcontractors they have used!

They are charging the main contractor for all labour costs even if some of their subcontractors may be gross status.

steve@bicknells.net

Are you a Property Developer or Investor for CIS Tax purposes?

Property developers

Property developers are included within the meaning of mainstream contractors for the Construction Industry Scheme (CIS) because their business activity is the creation of new buildings, or the renovation or conversion of existing buildings, or other civil engineering works. The same is true of a speculative builder.

Property investment businesses

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; it need not be involved in the construction, alteration or extension of buildings. Even so, if its property estate is substantial enough, its expenditure on construction operations may well cause it to fall within the meaning of a ‘deemed contractor’ (see CISR12050).

The Badges of Trade

There are also we established indicators which help determine whether you are an investor or a developer (trading), the factors below would indicate that you are a developer (which includes property flipping)

  • Profit Motive – did you buy the property with the selling it quickly for a profit
  • Property Finance – developers have loans and development finance (not long term mortgages)
  • Frequency – a company regularly buying and selling properties is likely to be trading and to be classed as developer
  • Duration – it the period between buying and selling is short that would indicate that you are not an investor
  • Work Carried Out – If major works are undertaken with a view to sale that sounds like a developer
  • Agreements – have you asked agents for sale prices or rental

Example from CISR12080 – Construction Industry Scheme Reform Manual – HMRC internal manual – GOV.UK (www.gov.uk)

A property investment business acquires a number of properties which it intends to let, but before letting, minor refurbishment is required to bring the properties up to a suitable standard to be able to let them. For CIS purposes we would see this as the normal activities of a property investor, and where the expenditure on such activities exceeds £3million in a rolling 12 month period then CIS applies.

The property investment business then acquires a large dilapidated hotel to add to its portfolio, and decides to convert the building into a series of flats which it will then individually let out. As a result, substantial development is required to the property to change the building to its new use. In respect of this particular development and contract we would regard the property investment business as having taken on the mantle of a mainstream contractor as its business activity is now that of construction operations.

steve@bicknells.net

Zero Rating Commercial Conversion First Grant of Major Interest (Residential)

Conversion of Commercial Buildings for example Office Buildings, Shops, Warehouses, Barns into Residential qualify for 5% reduced rate VAT in relation to the Conversion Costs. But when the first major interest is granted it will be Zero Rated giving full VAT recovery.

Note that Building Materials supplied separately to the contract for the conversion will be charged at 20% standard rate but you will recover that VAT.

The most common approach is to create a group with the subsidiary carrying out the conversion work and granting the first major interest, either by directly selling the first major interest or transferring the completed residential property as first major interest to the holding company

A Group will qualify for Group SDLT Relief (subject to conditions).

This means that full recovery of VAT has been achieved and no SDLT suffered, however, the converted property will be transferred at Market Value which could create a profit in the developing subsidiary.

If this isn’t done and the subsidiary rents out the property partial exemption may apply reducing the VAT recovery or limiting it.

Below are the key sections relating to VAT.

VAT Notice 708 Section 5.3 Non-residential conversion

A ‘non-residential conversion’ takes place in 2 situations. The first is when the building (or part) being converted has never been used as a dwelling or number of dwellings (see paragraph 5.3.1) for a ‘relevant residential purpose’ (see paragraph 14.6), and it is converted into a building ‘designed as a dwelling or number of dwellings’ (see paragraph 14.2), or intended for use solely for a ‘relevant residential purpose (see paragraph 14.6).

The second situation requires that in the 10 years immediately before (see paragraph 5.3.2) the sale or long lease, the building (or part) has not been used as a dwelling or number of dwellings or for a ‘relevant residential purpose’ and it is converted into a building either ‘designed as a dwelling or number of dwellings’ (see paragraph 14.2), or intended for use solely for a ‘relevant residential purpose’ (see paragraph 14.6).

Examples of a ‘non-residential conversion’ into a building ‘designed as a dwelling or number of dwellings’ include the conversion of:

  • a commercial building (such as an office, warehouse, shop)
  • an agricultural building (such as a barn)
  • a redundant school or church

VAT Notice 708 Section 7 Reduced rating the conversion of premises to a different residential use

Section 7.3

A qualifying conversion includes the conversion of:

  • a property that has never been lived in, such as an office block or a barn

But Zero Rating (0%) applies on the first grant of a major interest where a developer has converted a non-residential building into a home.

VAT Notice 708 Section 5.6 First Grant of a Major Interest

Subject to the conditions at paragraph 5.1.2, you can only zero rate your first sale of, or long lease (see paragraph 4.2) in, a building (or part of a building).

If you enter into a second or subsequent long lease in the building (or sell the building after leasing it on a long lease) you cannot zero rate your supply and it would normally be exempt from VAT

VAT Notice 708 Section 4.2 Granting a major interest in a building

You’re granting a major interest in a building when you sell, assign or surrender:

  • the freehold
  • in relation to England, Wales and Northern Ireland, a lease for a term certain exceeding 21 years
  • in relation to Scotland, the estate or interest of the owner
  • in relation to Scotland, the tenant’s interest under a lease for a term of not less than 20 years

steve@bicknells.net

Do you need a certificate from the client to zero rate or reduce rate construction VAT?

Dwellings

The rules are in the VAT Notice 708 and in section 17.1 it states

There’s no requirement to hold a certificate for zero-rated or reduced-rated supplies in connection with buildings that will be used as one of the types of dwelling described at paragraphs 14.2 to 14.5.

Zero Rating – an example would be building a new house

Reduced Rating – this applies to converting a non-residential building to a dwelling or multiple dwellings

If your builder needs further details just point them at VAT Notice 708.

Don’t accept invoices which have the wrong VAT rate on them, even if you can claim the VAT back because HMRC will only accept the recovery of VAT when its charged at the correct rate

When do you need a Certificate?

You need to hold, within your business records, a valid certificate when you make any zero-rated:

  • or reduced-rated supply in connection with a building that will be used solely for a ‘relevant residential purpose’ – see paragraph 14.6
  • supply in connection with a building that will be used solely for a ‘relevant charitable purpose’ – see paragraph 14.7

Possession of a valid certificate does not mean that you can automatically zero rate or reduce rate your charge. The certificate merely confirms that the building is intended to be used solely for a qualifying purpose. You must meet all of the conditions explained in the relevant sections of notice 708 to zero rate or reduce rate your supply.

The customer for the zero-rated or reduced-rated work issues the certificate. The certificates at section 18 of VAT Notice 708 can be used, or the issuer can create their own certificate provided it contains the same information and declaration.

The 2 available certificates confirm that you’re either eligible to receive:

  • zero-rated or reduced-rated building work (the certificate can be found at paragraph 18.1)
  • a zero-rated sale or long lease (the certificate can be found at paragraph 18.2)

What if you get it wrong?

If you issue an incorrect certificate, you may be liable to a penalty equivalent to the amount of VAT not charged. A penalty is not VAT and, if you’re registered for VAT, you will not be able to recover it as input tax.

A penalty will not be issued, or will be withdrawn, if you can demonstrate that there’s a reasonable excuse for issuing the incorrect certificate.

What if the use changes?

If you have obtained zero rating for the construction or acquisition of a building (or part of a building) because you certified that it would be used solely for a ‘relevant residential purpose’ or a ‘relevant charitable purpose’, HMRC expect that the building will be used solely for either or both of those qualifying purposes for a period of, at least, 10 years following completion of the building.

If the building ceases to used solely for either or both of those qualifying purposes within that 10-year period, if that use decreases or if the building is disposed of, a taxable charge comes about, on which you must account for VAT.

What about Materials?

Retailers and builders merchants charge VAT at the standard rate on most items they sell.

Builders charge VAT on ‘building materials’ that they supply and incorporate in a building (or its site) at the same rate as for their work. Therefore, if their work is zero-rated or reduced-rated, then so are the ‘building materials’. But some items are not ‘building materials’ and remain standard-rated.

steve@bicknells.net

Factsheet – Construction Industry VAT – Reverse Charge

 

Reverse Charge for the Construction Industry starts in October 2019, its complicated and will be confusing!

Read our 2 page fact sheet to understand how you need to account for VAT.

The new rules will affect Subcontractors and Contractors.

Click here to get the factsheet

steve@bicknells.net

What if you fail to register for CIS

The Construction Industry Scheme (CIS) applies to anyone who carries out construction work as a trade, in other words developers, contractors, building maintenance and repairs, decorating, property conversion, basically if you use sub-contractors to work on a building its probably within CIS. It does, however, exclude property investors (although this could change soon) and domestic householders.

Tax Aid have a good example of how it works

Rob is asked to undertake some repair work on Ben’s private house. He asks Wendy to help him with the electrical work. Wendy is working on a self-employed basis for this contract. Ben pays Rob without deduction of tax as Ben is a private householder. Rob then pays Wendy.

Rob should register under CIS as a contractor before making the payment to Wendy. Rob should ask Wendy for her UTR and check her CIS status with HMRC. He should then pay Wendy net of 20% tax or net of 30% tax depending on her status with HMRC (exceptionally, if Wendy is entitled to register with HMRC for gross payment, then HMRC would tell Rob that he can pay Wendy without deduction of tax; gross payment will only apply to larger businesses).

If HMRC advises Rob that Wendy is registered under CIS (but not for gross payment), then Rob will keep back 20% tax and pay this CIS tax across to HMRC on Wendy’s behalf.

If Rob failed to register as a contractor under the CIS scheme he could face very big penalties. These include a £3,000 fine for not keeping CIS records, and a £100 per month penalty per missed return (and returns are due monthly).

Failing to register for a number of years could lead to penalties in the tens of thousands of pounds. This can happen even when all the workers are registered as self-employed and have paid the tax due on their income.

In summary the penalties are:

The maximum penalty is currently £3,000 for failing to register then there are late filing penalties

How late the return is Penalty
1 day late £100
2 months late £200
6 months late £300 or 5% of the CIS deductions on the return, whichever is higher
12 months late £300 or 5% of the CIS deductions on the return, whichever is higher

For returns later than this, you may be given an additional penalty of up to £3,000 or 100% of the CIS deductions on the return, whichever is higher.

There is no lower limit for CIS registration and the penalties can be harsh as demonstrated in the cases below

Brian Parkinson a gardner and lanscaper who used occasional subcontractors and got £31,500 in CIS Penalties!

The FTT heard evidence that little or no loss of tax resulted from this omission, as the amount of tax Parkinson ought to have deducted under the CIS was put at £837.90. [Brian Parkinson and the Commissioners for Her Majesty’s Revenue & Customs TC04526; Appeal number: TC/2013/00224].
This comprised £6,000 (5 x the £1,200 maximum) charged under the Taxes Management Act 1970 (TMA 1970), s98A(2)(a) and also month 13 penalties of £25,500 charged under TMA 1970, s. 98A(2)(b). – See more at: https://www.accountancylive.com/partial-win-gardener-over-%E2%80%98excessive%E2%80%99-cis-penalties#sthash.zJA59Gjv.AfCNNGRJ.dpuf
Or how about CJS Eastern an installer of lightning conductors

INCOME TAX – subcontractors – appellant company contracted with a third party provider to supply “operatives” – third party provider “net” for CIS purposes – company’s failure to make CIS returns  – fixed monthly penalties of £28,500 – Month 13 penalties of £56,500 – whether reasonable excuse – held, no – whether disproportionate as a breach of A1P1 – Tribunal’s jurisdiction and interaction with mitigation –  Bosher followed – fixed penalties upheld – Month 13 penalties set aside as excessive – appeal allowed in part

https://cases.legal/lang-en/act-uk2-156151.html

If you work in construction make sure you register and comply with CIS!

steve@bicknells.net

Are my costs Capital or Revenue expenditure?

Stress business woman

It makes a big difference to your tax whether you can offset costs as revenue expenditure or remove costs because they are capital expenditure

HMRC published a guide on this in September 2016 and have circulated in in their Agent Alert Self Assessment Special January 2016.

https://www.gov.uk/government/publications/hmrc-capital-vs-revenue-expenditure-toolkit

The Toolkit is really useful and covers lots of problem areas:

  • Acquisition, improvement and alterations to assets – highly relevant to property investors
  • Legal and Professional – including how to handle unsuccessful property purchases – which are a capital cost – and Business Owner Training Costs
  • Finance Costs
  • IT Costs – including websites
  • Intangible assets – such as Goodwill

steve@bicknells.net