CIS: coming soon to a site near you...

In the dark about CIS? Frances Strickley from the employment unit of solicitors firm Thomas Eggar explains everything you need to know about the changes to the scheme - and what you should be doing before the deadline next April.

TEXT: The Construction Industry Scheme (CIS) outlines rules for contractors and subcontractors in the construction industry, and details the tax and National Insurance treatment both receive.
The HM Revenue & Customs (HMRC) has launched an audit into the operation of its scheme. This follows a number of complaints by trade unions about the exploitation of subbies and is designed to address the government's need to increase National Insurance contributions (NIC).
The stated aim of this audit and the ensuing changes to the CIS - set to come into force in April 2006 - are to reduce the regulatory burden on construction businesses but, more importantly for HMRC, to ensure everyone in the industry understands and meets their obligations to apply the correct employment status to workers. To support this, the HMRC has sent thousands of letters to contractors and subcontractors on the issue of employment status.
The current CIS regime - who does it affect?
The CIS only affects contractors and subcontractors. However, these terms are not straightforward and are much wider than would first appear.
Contractors include not just construction companies and building firms, but many construction industry clients. For instance, non-construction companies spending more than 1m per year on construction work can be deemed as contractors. CIS applies to workers who are self-employed and not to employees subject to PAYE.
Dealing with tax and National Insurance matters
Under the scheme, a contractor has to make deductions for tax and NIC, in certain situations, when making a payment to a subcontractor under a contract related to construction operations. The CIS provides for subcontractors working under it to hold either Subcontractors Tax Certificates or Registration Cards. Those with Registration Cards (CIS4) have 18% deducted from payments due, in order to account for tax and NIC. Those with Subcontractors Tax Certificates (CIS6) are paid gross and therefore account for tax and NIC themselves.
Employed or self-employed?
The HMRC investigations are trying to pinpoint subcontractors who are not genuinely self-employed and should be treated as employees and, therefore, should be paying PAYE and NIC.
The HMRC letters to contractors make it clear that HMRC considers it is the conditions and facts of the engagement that determine whether a subcontractor is employed or self-employed and not whether they hold a CIS card.
Defining someone's employment status is not necessarily straightforward. It is determined by examining the facts of each case relating to each individual. HMRC uses various factors to assess whether or not a person is employed, as do the courts, such as:
<25A0> Whether the worker is providing work personally.
<25A0> Whether they are in business for their own account.
<25A0> Is the worker free to accept or reject any contract offered?
<25A0> Is the contractor obliged to offer work to the worker?
<25A0> Is the worker subject to supervision, control, direction and management?
<25A0> Can the worker be told what to do, where to do it, when to do it and how to do it?
<25A0> Is the worker genuinely running a business? Is there capital invested? Is there a financial risk? Can the worker engage their
own helpers?
Difficulty often arises when employers take on casual workers, either directly or through employment agencies, who they continue to engage for a considerable period without realising that the individual's status can radically change as a result.
If a subcontractor is not an employee, it is still possible that they are a 'worker' within the definitions found in employment legislation.
Implications of employment status - risks involved
Liability for payment
The main implication of a subcontractor being employed is that PAYE and NIC are payable. The risk to the contractor is that the HMRC claims up to six years' unpaid tax, NIC and interest payments where an individual has been incorrectly treated as a self-employed subcontractor instead of an employee. The contractor will be liable for these payments unless the subcontractor has agreed to indemnify the contractor against liability.
Employment law liability
The secondary risk to the contractor is the employment law liabilities that result from either a subcontractor being an employee or alternatively a worker. If they are in fact an employee, these rights include entitlement to holiday pay, sick pay and redundancy pay, among other rights. If they are workers, they have equivalent rights to employees under the Working Time Regulations, and to the National Minimum Wage.
These issues are likely to become a problem only if a
contractor has to lay off a lot of subcontractors, say in a recession, and they find it difficult to find new employment. In such circumstances, the subcontractors are more likely to argue that they were employed or, at the least, were workers, to try to secure protection and/or redundancy pay.
Other issues
Other practical implications include completing a P46 if there is no P45 from a previous employer, sending the form to the tax office to notify new starters, operating the emergency code if this is an employee's 'only or main' job and any additional costs and their implications on tenders.
Identifying changes in status
It is possible that the HMRC could come in and carry out an audit on individual contractors. Therefore, a contractor must take care in assessing the status of its
subcontractors.
It may be wise to complete spreadsheets detailing each subcontractor and list whether they are CIS-registered, employed etc. The spreadsheet could also show their start date, thereby highlighting length of service and enabling contractors to keep track of the amount of work done for them by each individual subcontractor.
This will also identify whether they have been with the contractor for sufficient time to be deemed employed.
Contractors may consider avoiding labour-only engagements and refrain from giving subcontractors benefits in kind, for example company vans, which suggest that there is no capital investment by the subcontractor. Also avoiding the use of time sheets, which suggest control over the subcontractor may
be considered.
In theory, of course, these solutions seem fine, but in practice contractors may find it more difficult to follow them. The reality is that in order for a main contractor to meet its own contractual obligations it has to control its subcontractors and frequently provides plant and equipment for use by subcontractors. The distinction between employed and self-employed is not as clear as HMRC sometimes suggests.

Limited liability service companies
The solution may be to contract with a limited liability service company of which the subcontractor is an employee rather than with the subcontractor direct. In this scenario, the service company will be responsible for the subcontractor's PAYE and NIC instead of the contractor.
There have only been rare cases where the HMRC has defeated the collection of tax and made it the contractor's responsibility. This doesn't, however, exempt the contractor from employment law.
An alternative may be to contract with a payroll agency or have labour supplied by an employment business. However, the increase in overheads and the need to maintain certain subcontractors' skills may make these solutions impractical.
The new CIS regime
In April 2006, the new CIS regime will begin and the major changes will be in the records that need to be kept and new processes and communications with HMRC.
Cards and exemption certificates will go, but subcontractors will continue to register with the HMRC to be eligible for gross payment status.
Contractors will have to submit periodic returns to HMRC listing all the subcontractors paid in the tax period.
The status issues outlined in this article will remain and the obligation on contractors to assess the correct employment status of those they engage will be underlined by a formal declaration on the periodic return completed by the contractor.
Conclusion
Contractors need to be more aware of the importance of auditing the status of their subcontractors. Contractors who just sit tight may find that the HMRC comes knocking. <25A0>