Subcontractor and CIS Deductions made by Contractor

Subcontractor and CIS Deductions made by...

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Hello,

I have a client who is of a reasonable size and supplies and fits kitchens in new build properties.

To date the client base has been regional builders with 30/40 plots being completed at a time. 

My client has raised sales invoices showing kitchen units, white goods and labour costs seperatley and their clients have only deducted CIS tax at 20% from the labour element on these invoices.

The client has won a contract for a national builder who has requested that the cost (to my client) of materials (ie kitchen units, white goods) etc should be shown on the sales invoices as it is only this cost that can be deducted prior to calculating CIS tax at 20%. HMRC guidence indicates that this is correct.

My points/questions are:-

1) I have not come across this before and contractors have simply deducted CIS tax at 20% of the labour cost shown on the invoices. Is this in line with others experiance?

2) My client is concerened about highlighting the margins he makes. HMRC guidence indicates that the contractors can request copy purchase invoices if he feels that the cost price is not accurate. What experiance do other have in relation to this?

I understand that my client can apply for gross payment status and this is likley to be something that he will do. To date he has been more than happy with a set off to PAYE rather than having a large payment each month and cash flow has not been an issue.

Thanks in advance

Replies (20)

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Euan's picture
By Euan MacLennan
31st Jul 2014 14:07

What is the problem?

Strictly speaking, CIS tax is deducted from the total invoice amount after deducting VAT, CITB levy and the amount which the sub-contractor actually paid for materials, consumables and plant hire, rather than just from the labour element charged by the sub-contractor.  If your client has been adding a margin to his actual cost of materials and thus, reducing his labour charge with the result that less tax is deducted, he has been getting away with a fiddle.  As you have realised, the national builder is playing it by the book.  Your client will have to do what he should always have been doing which is to include all his profit margin in his charge for labour and have tax deducted accordingly.

However, if your client qualifies for gross payment status, just get on with it and the problem will go away.  If he likes the idea of regular saving against his tax bill, tell him to put 20% of his labour charge into a savings account each month.

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Replying to Justin Bryant:
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By Elgin
31st Jul 2014 14:36

Thanks Euan.

I'm not sure that my client has been getting a way with a 'fiddle'. My understanding is that it is the contractor who must satisfy himself that the materials element is not overstated and that he can request purchase invoices to confrim this. If these are not provided it is my understanding that they must satisfy themselves 'as far as possible' that the material element is not overstated.

My point was whether my clients scenario is common practice and invoices are taken at face value.

I am also interested in how others have seen invoices prepared and how the cost of materials is dealt with and shown.

 

 

 

 

 

 

 

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By Steve Kesby
31st Jul 2014 14:21

Separate contracts?

CIS only applies to contract payments under construction contracts.

If you contract under a single contract to supply and fit, the whole contract is a contract relating to construction operations. Then the profit element is liable to CIS deduction, as Euan says.

If, however, you contract separately for (i) the provision of the materials (not then a contract relating to construction operations), and (ii) the fitting (always a contract relating to construction operations), you will shelter any profits on the materials from both CIS deduction and the scrutiny of the end customer.

That's advice provided by the man that once said to me, "Mr Kesby you don't need to tell me what IR14 says; I wrote it." IR14 was the then equivalent of CIS340, but the construction contract principle remains the same.

See CISR14020 and CISR14030.

Obviously, whether the national building firm would go along with it is a different issue.

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By johnjenkins
31st Jul 2014 14:26

Sorry Euan

but you are wrong. It's not a fiddle to "mark up" material costs. The material content of the sales invoice does not have to be linked to the cost of the materials. (obviously you can't charge all for materials and labour for free).

If you get a nice discount from a merchant why should you have to pass that on to the main contractor?

The big boys" know that this goes on and want to stop it by using CIS "guidlines"

As long as all is declared and tax paid on the profit of the business then there is no fiddle.

I have clients that don't bother splitting the invoice up and therefore get a bigger rebate. CIS is just a contribution towards the tax payers bill.

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Replying to SXGuy:
Stepurhan
By stepurhan
31st Jul 2014 15:19

Check the law

johnjenkins wrote:
but you are wrong. It's not a fiddle to "mark up" material costs. The material content of the sales invoice does not have to be linked to the cost of the materials. (obviously you can't charge all for materials and labour for free)
The Finance Act 2004 says. (my emboldening)

Finance Act 2004 wrote:
61Deductions on account of tax from contract payments

(1)On making a contract payment the contractor (see section 57(3)) must deduct from it a sum equal to the relevant percentage of so much of the payment as is not shown to represent the direct cost to any other person of materials used or to be used in carrying out the construction operations to which the contract under which the payment is to be made relates.

Check it for yourself here if you like.

If you are saying you would run with the argument that "direct cost" in this sense is the cost to the contractor as determined, with markup, by the subcontractor then I wish you luck. I personally don't fancy your chances much.

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By johnjenkins
31st Jul 2014 14:35

Sorry Steve

you are also wrong. It is only the labour element that has CIS deduction not the profit. 

You're not going to reduce your labour charge just because you increased your material charge are you?

 

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blue sheep
By NH
31st Jul 2014 15:20

in practice

I have never known a contractor to query the mix between materials and labour as I would assume the price of materials and labour will have been agreed beforehand

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By Steve Kesby
31st Jul 2014 15:57

@ John

It's definitely only those elements to which Euan refers that are not liable to CIS deduction. CIS deduction certainly applies to the profit element and not just the labour element as you suggest.

Indeed, in my own time working for a large contractor I have specifically instructed tax to be deducted on the whole amount of invoices which showed only a labour element, and no materials element, for that very reason. Amount for materials were also verified if they exceeded a threshold percentage (the amount's a secret).

If stated materials costs have been inflated by a mark up element, then it is up to the contractor to challenge it, because HMRC can come back after the event (under regulation 13 of the regulations) and do so and hold the contractor liable for the amount that should have been deducted but wasn't.

Any contractor that doesn't challenge a materials element that appears high, or excludes from deduction anything other than the materials, VAT and CITB levy, faces that potential risk.

You may not believe me, because I've only read the law, but HMRC do say pretty much exactly what the OP has said at CISR15060.

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By nick farrow
31st Jul 2014 16:23

interesting

I remember going to talk by HMRC about this about 8 years ago when I think the new system 1st came in and being very surprised that on the one hand the subcontractors were supposed to be self-employed businessmen/women in business on their own account and yet they were being asked to be explicitly reveal the mark up of materials on their invoices - in practice it seems that you can charge a mark-up, and not suffer a deduction provided you don't take the p***

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By johnjenkins
31st Jul 2014 16:26

The onus

is certainly on the main contractor to determine if the cost of materials is reasonable (big word that). The reason for that is so that subbies cannot charge for materials that don't exist purely to reduce the tax deduction. There is a big difference between the two.

Unfortunately some main contractors are trying to use CIS in order to find out how much "mark-up" subbies are making on materials with the view to stopping the practice. (Could be illegal) 

As long as the subbie pays their tax bill there can be no problem.

HMRC don't even go after the "big boys" for not deducting 20% CIS off on account payments.

To summarise:- the law is there to stop subbies claiming or pumping up materials on an invoice in order to reduce the 20% CIS deduction, not to stop subbies making a reasonable profit on the sale of materials.

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Euan's picture
By Euan MacLennan
31st Jul 2014 16:48

@John

It is not up to you to declare that the law is not there "to stop subbies making a reasonable profit on the sale of materials".  As the rest of us have pointed out, the law is quite explicit in stating that it is only the direct cost of the materials, not the cost plus a mark-up, that can be deducted from the total in arriving at the balance on which to calculate tax.  You may not think it is right, but that is the law.

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By ShirleyM
31st Jul 2014 16:53

There is an alternative

If the subbie doesn't split the cost between materials and labour, then he doesn't have to justify the cost of the materials and could include a mark-up, but he will suffer 20% deduction on the whole amount.

This may need prior agreement of the contractor, though.

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By ann domonkos
31st Jul 2014 20:22

Apply for gross

I would apply for gross sometimes the larger boys ask for to much info and then want you to slash margins....one of my clients who was on a gross payment was asked to provide a detailed profit and loss account....

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By johnjenkins
01st Aug 2014 16:41

@Euan

The wording of the Act is "direct" cost of materials. HMRC have interpreted direct to mean what the subbie paid for them. I choose to interpret direct to mean what the subbie charges for the materials. The safeguard for HMRC being that the contractor must satisfy themselves that, what is charged, is reasonable.

I would think the High Court would take a dim view of someone trying to stop a business making a reasonable profit. 

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Replying to lionofludesch:
Euan's picture
By Euan MacLennan
01st Aug 2014 18:21

@John

johnjenkins wrote:

The wording of the Act is "direct" cost of materials. HMRC have interpreted direct to mean what the subbie paid for them. I choose to interpret direct to mean what the subbie charges for the materials.

As Step has pointed out, s.61(1) FA 2004 says:

"On making a contract payment the contractor (see section 57(3)) must deduct from it a sum equal to the relevant percentage of so much of the payment as is not shown to represent the direct cost to any other person of materials used or to be used in carrying out the construction operations to which the contract under which the payment is to be made relates." [my emphasis]

You cannot choose to read this as the direct cost to the contractor as charged by the subbie.  The law explicitly states that it is the direct cost to any person other than the contractor, which would almost always mean the cost to the subbie.

You have not chosen to argue the one slightly ambiguous phrase in the section.  Your only possible wiggle room is the phrase "shown to represent" - "shown", perhaps meaning "written on the subbie's invoice", as "representing" the cost of materials, but not necessarily the actual cost to the subbie.  Are you relying on this interpretation?

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blue sheep
By NH
01st Aug 2014 16:51

back in the real world

I very much doubt any contractor would pay for materials that were priced unreasonably, the law is there so that no collusion between subbie and contractor takes place to artificially lower the labour and hike the materials.

I dont see the contractor having the responsibility under law to check that the materials are at cost, rather that they are priced at a reasonable level even if that includes a small element of profit for the subbie, which they will have agreed before the job anyway.

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By johnjenkins
04th Aug 2014 10:03

@Euan

I like the word wiggle, so much better than wriggle.

I try to use common sense when I do things and make decisions. If I know 100% that a PAYE coding is wrong then I will use what I consider to be the correct one and not the incorrect one HMC have issued.

So I apply common sense to this scenario. I'm sure when this law was made, government did not intend to stop subbies making money. However they had to "safeguard" from abuse.

So taking your interpretation Direct cost could mean the actual cost from the manufacturer (direct cost to any person other than the contractor) so the builders merchant can't make a profit.

I'm very happy with my interpretation and have now taken up wiggling. 

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Replying to Glennzy:
Red Leader
By Red Leader
04th Aug 2014 10:24

Steve moonlighting?

Is it just me who did a double-take when Steve referred to his work for a contractor?

For a moment I had visions of him doing a bit of bricklaying or some such.

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Replying to Glennzy:
Euan's picture
By Euan MacLennan
04th Aug 2014 12:27

@John

johnjenkins wrote:

I like the word wiggle, so much better than wriggle.

I'm very happy with my interpretation and have now taken up wiggling. 

You may be interested in this link!

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By johnjenkins
04th Aug 2014 12:45

Who says

Accountants are boring? I even took the tour.

I have to admit that I have never heard of the phrase "wiggle room" which is great because I love to learn something new everyday. Thank you Euan. 

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