Browsing Any Answers recently I spotted the first question of I suspect many on the topic I have been waiting to see for over a year now.
“A client has been moved from gross to net under CIS. He doesn’t think he has done anything wrong and is frantic! Nobody can tell me what it is all about – except it’s something to do with sections 66(1) of a Finance Act (unspecified). Help!” Or words to that effect.
So what is this all about? And why have I been expecting this, and will it be widespread?
We’ll start with the technical details. Most people know that one of the aims of the new CIS scheme which came in nearly a year ago was to improve compliance in the construction industry. This is part of that objective, and it is going to present some serious problems. Under the old scheme, it was normally when the gross payment certificates were renewed that subcontractors were called to account for their tax compliance (or lack of it) during the three preceding years. If they fell foul of the rules, then there was the possibility of pleading before the Commissioners that the compliance breach was “minor and technical” – a term which was not explained in law, but which the Commissioners could on occasion treat as quite broad, thus solving the problem for subcontractors in this position.
Under the new scheme, we are faced with Section 66(1) Finance Act 2004, supplemented by the Regs, SI 2005 No 2045. Section 66 says that HMRC may at any time raise a determination transferring a subcontractor from gross to net payment status if an officer believes that were the subcontractor to apply for registration for gross payment at that time he would be refused. In simple terms, this means that as soon as you are in breach you can be kicked off gross status.
Now the practical side. In October 2007, HMRC announced that the TTQT was starting. This stands for Tax Treatment Qualification Test (or something close to that). Under this, in the first month one twelfth of gross registered subbies were selected for scrutiny at random. Their tax compliance over the previous 12 months (the shorter period was introduced under the new Scheme) is then looked at and if they have unacceptable breaches they receive a determination moving them to net status and notice of right of appeal. In the following month a further sample of one eleventh of the remainder are checked and so on until all gross registered subbies have been checked over the course of a year. The process then starts again with a random sample of one twelfth. So every gross registered subcontractor gets looked at every year, but it is not necessarily a year between compliance checks – it is anything from one month to two years. That way, nobody knows when they are being (or will be) checked.
The breaches of tax compliance can arise in almost any area but not VAT, oddly, as the legislation was written when the Inland Revenue was still separate from Customs and Excise. However, HMRC do not expect every subcontractor to be 100% perfect, so the principle of the “minor and technical” default is still with us, but is sadly not within the remit of the Commissioners. This is where the Regulations come in. Table 3 which is in Regulation 32 sets out the “slippage” permitted. It describes the situations under which a subcontractor will be regarded as compliant, even where there have been breaches. However, there is no room for interpretation and the limits are quite strict. They are better described in Fact Sheet 343 (which is available in a number of foreign languages, including Polish) :
“To pass the compliance test, you and any business partners (or your company and each of its directors) must, during the 12 months up to the date of the application, have done all of the following.
- Completed and returned all tax returns sent to you.
- Supplied any information to do with your tax that we may have requested.
- Paid by the due dates
- all tax due from yourself or the business
- all your own National Insurance contributions (NICs)
- any PAYE tax and NICs due from you as an employer
- any deductions due from you as a contractor in the construction industry.”
“When considering whether you have passed the compliance test, we will disregard, during the same 12 month period, any or all of the following.
- Three late submissions of the monthly return – up to 28 days late.
- Three late payments of CIS/PAYE deductions – up to 14 days late.
- One late payment of Self Assessment tax – up to 28 days late.
- Any employer's end of year return made late.
- Any late payments of Corporation Tax – up to 28 days late, including where any shortfall in the payment has incurred an interest charge but no penalty.
- Any Self Assessment return made late.
- Any failures classed as 'minor and technical' in relation to your obligations under the old Scheme, where these fall within the 12-month period up to your application.”
Looking at this, you will see immediately that if your client was one of the businesses which failed to send in any new monthly CIS returns at all by the end of September 2007, then as soon as his “number comes up” for TTQT he will be reclassified as net, for submitting at least 5 late returns. Many subcontractors are also contractors, so this is a real risk.
So now it is clear what is expected of subcontractors, but what can you do when the dreaded letter arrives? First the grounds of appeal is that the subcontractor has “reasonable excuse” for his failure. To establish this you will need to know exactly what breach is the fatal one so that you can consider whether he has sufficient grounds of appeal. You will need to lodge this within 30 days and the change in tax status does not take effect until after the period allowed has expired or the appeal has been determined.
For those who lose their gross payment status, the cash flow impact can be a disaster, and may even bring the business down. Are there any other mitigating steps you might consider? Well, it is a long shot, but you might improve things by incorporating the client, provided he has some staff or subcontractors of his own. In this case, the CIS tax suffered can be set off against CIS or PAYE / NIC due each month, thus eroding the loss of cash flow. For an unincorporated business no such set off is possible, as the tax suffered is set against the eventual liability for the year, so he must wait for the credit. However, this will not save everyone. Any business facing making gross subcontractor payments out of net receipts is quite clearly in serious financial trouble. There is good evidence to suggest that this issue will become quite widespread as time goes on.