Is it material? – A CIS risk explained

HMRC have always been interested in payments made to subcontractors for the cost of materials used on a project. The reason for this is that the legislation allows those costs to be repaid to the subcontractor without a CIS deduction. In HMRC’s mind this gives a motive for those costs to be inflated. Doing so is a low risk action for the subcontractor as any liability will be that of the contractor.

What are materials?
The definition includes all of the obvious things such as bricks, paving slabs, piping and fixings that a subcontractor may supply as part of a construction project. It also includes the cost of renting or hiring equipment or scaffolding. It doesn’t cover plant or equipment owned by the subcontractor, although consumables such as fuel used in running the plant can be claimed. The legislation makes it clear that the amount which can be excluded from CIS deduction is limited to the direct cost of materials used or to be used in carrying out the construction operations. This clearly excludes any mark up on the costs or any notional hire charge for equipment or plant owned by the subcontractor. In simple terms it covers amounts paid away by the subcontractor on materials, plant or equipment that relate entirely to the project they are undertaking for the contractor.

HMRC’s approach
In 2012 HMRC won a case before the first tier tax tribunal (Flemming & Son Construction (West Midlands) Ltd v Revenue & Customs) this looked in some detail at how a contractor should demonstrate that they were satisfied that the amount claimed represented the actual direct cost of materials as required under the CIS Regulations. Prior to this case it was common practice for HMRC to accept fixed percentages of the contract cost as relating to materials. That percentage was different from trade to trade and in some cases varied according to the location. For example, in Northern Ireland where labour was cheaper than in the rest of the UK but materials costs were higher the accepted materials percentage would be higher. Following the decision in Flemming, that approach is no longer accepted by HMRC. 

The Flemming decision tells us that although there are a number of ways available for a contractor to satisfy themselves that the cost of materials is not excessive whatever checking system is used it must be capable of showing to a third party that the decision is reasonable. As a result, evidence of how the decision was made has to be available to HMRC compliance officers. 

HMRC’s standard approach is to review subcontractor invoices and to challenge those with materials (especially for scaffolding and plant hire). The contractor has to be able to show that they have a mechanism in place to check the cost of materials claimed. This has to be more than a simple agreement with the subcontractor. In my experience cross checking the cost against builders’ merchant price lists is acceptable as covering cost and comparing amounts to the contractor’s own Quantity Surveyor’s calculations will be sufficient to cover amounts of materials shown on an invoice. Costs of scaffolding and plant hire are more difficult to prove as HMRC will ask how the contractor can be sure that those items were not supplied from the subcontractors own pool of equipment. The only way to be certain is to see evidence of them being hired by the subcontractor.

A check on the valuation of materials is now a standard part of any HMRC CIS compliance check. This is for one simple reason; many contractors still do not properly review the costs claimed by their subcontractors, or do not provide acceptable evidence that the amount allowed does no more than represent the true cost. This creates an easy win for HMRC. While HMRC will initially only carry out a sample check if they find issues they will look at all of the invoices which show claims for materials, for at least that particular subcontractor and more likely for all subcontractors. They will challenge the costs claimed on a subcontractor by subcontractor basis asking why the contractor accepted the cost of materials as being reasonable.

Why is it important
At its simplest, getting it wrong will cost the contractor money! Although there is an ability to seek an offset against any under deducted CIS where the subcontractor has declared the income from the contract and accounted for the tax due, this doesn’t cover interest and penalties. To make matters worse, any penalty will be calculated on the full amount of the under deduction and not the amount due after the setoff. Bear in mind that some subcontractors may not have made a return of the income or may not yet be due to make a return which means that any additional CIS due on those amounts will still fall upon the contractor. This can be significant where the cost of materials is a large part of the cost charged by the subcontractor such as with supply and fit arrangements.

There is also the additional risk for contractors who hold gross payment status that this will be considered a significant enough compliance failure to lead to withdrawal of that status.

How to get it right
Contractors need to ensure that they have a mechanism in place for reviewing invoices which include the cost of materials. This must include some record to show when it was checked and if it was approved or rejected. An explanation of how the cost of the materials allowed was established needs to be available either as a note on the invoice or as part of a recorded process of invoice checks.

It would be good practice to notify subcontractors that the cost of materials will be reviewed and to warn them that invoices may be called for as evidence. This could be included as a contractual term if required.

If you would like any further information on this topic please contact David Geldard, Senior Tax Consultant, within our Contract Solutions team on 0345 0660 035 or email.
The information provided on this site is of a general tax nature and may not apply to any particular set of facts or under all circumstances. It should not be construed as tax advice and does not constitute an engagement of Abbey Tax. Tax laws are constantly changing. The information on this site was accurate at the time of posting and we make every effort to keep it current, however we are not responsible for outdated material.