The Construction Industry Scheme for businesses in the future energy sector

In the fourth article of our series, Tax in 2024 for the future energy sector, the TLT Tax team provides an overview of the Construction Industry Scheme and how it impacts businesses engaging or undertaking the construction of any type of generation or storage asset.

What is the Construction Industry Scheme?

The Construction Industry Scheme (CIS) is a special tax deduction scheme which requires contractors to make tax deductions from certain payments made to subcontractors relating to construction work.

Why is the CIS relevant?

The CIS continues to be an area of focus for HMRC. Last year a consultation was published with a view to strengthening the CIS and that consultation led to legislative changes to tackle abuse of the CIS.

As energy projects often involve construction works (for example the construction of an on-shore or off-shore wind, ground mounted solar farm or even an energy storage project in order to generate electricity), it is important that those operating in the sector understand when the CIS will apply and their obligations under it.

Although exemptions may be available to those constructing generation and storage assets to enable them to fall outside the CIS, the assessment needs to be carried out by each business on a case-by-case basis.

When does the CIS apply?

The CIS applies where a payment is made by a contractor to a subcontractor under a construction contract, which is a contract relating to construction operations carried out in the UK.

What are construction operations?

The definition of construction operations is wide and covers most work that is done to a permanent or temporary building or structure or civil engineering work or installation. The construction of most generation and storage assets is likely to fall within this definition.

Who is a contractor?

A contractor is broadly defined in the relevant legislation and it is important to understand that it has a meaning that is wider than it normally has in the construction industry. Effectively this means that an electricity generating business can fall within that definition even though its business is power generation and it is merely subcontracting the construction work out to third parties.

There are two groups of contractors under the CIS: “mainstream contractors” and “deemed contractors”.

A mainstream contractor is, broadly, a business that includes construction operations and either pays others to carry out the construction works or supplies labour to carry out the construction works. As an example, a mainstream contractor could be a construction company but could also be a developer such as a property developing company.

A deemed contractor is, broadly, a business whose trade or activities do not normally involve building or construction but who regularly carry out or commission construction work on their own premises or investment properties. When a deemed contractor’s rolling annual expenditure on construction operations exceeds £3 million, the business will need to register and operate the CIS as a contractor (if not already registered).

Therefore, whilst an energy generating business whose sole business is the provision of solar or wind power may not be treated as a mainstream contractor, it may still fall within the definition of a deemed contractor for CIS purposes by subcontracting significant construction work to third parties.

Who is a subcontractor?

A subcontractor is, broadly, a person or body who carries out construction operations for a contractor, whether through its (or its employees) own labour or by arranging for another business to carry out the work.

How does the CIS operate?

If the CIS applies, the contractor must:

• register with HMRC when it takes on and pays its first subcontractor;
• deduct tax at source from any payment (other than a payment which represents the cost of materials) made to a subcontractor; and
• pay the amount deducted to HMRC, similar to the PAYE arrangements between an employer and employee.

If a required deduction has not actually been made from a payment to a subcontractor, the contractor is still responsible for paying that amount to HMRC.

Contractors may have to pay penalties if they do not pay the amounts due to HMRC on time and in full.

A contractor will also have ongoing compliance obligations under the scheme.

How much tax must be deducted?

The amount of tax that the contractor must withhold will depend on the status of the subcontractor. The contractor may need to verify with HMRC the status of a subcontractor under the CIS.

The standard rate of deduction is 30%. However, if the subcontractor registers with HMRC the standard rate of tax deduction can be reduced to 20% and can be reduced still further, such that no deductions for tax are required, if the subcontractor is registered for gross payments (subject to certain conditions being satisfied).

Are there any exemptions to the CIS?

There are some payments made under a construction contract to which the CIS may not apply. This includes the recent change of law regarding certain payments from landlords to tenants for construction works. However, the most relevant of the exemptions for energy generating businesses is for payments which relate to own builds. Broadly, specific payments by deemed contractors for construction work on a property they use for their own business will be excluded from the CIS.

How might the CIS apply in the context of the construction of generation or storage assets?

Since the definition of “construction operations” is so wide, any contract relating to any work on a new site, building or structure in the UK may potentially fall within the scope of the CIS, including energy generating sites such as ground mounted solar or onshore / offshore wind farms and even energy storage. This would include contracts pursuant to which construction work is subcontracted to a third party.

Any business undertaking or engaging construction operations will therefore need to consider if it is a mainstream contractor or a deemed contractor for the purposes of the CIS.

If a core activity of the business is construction, it is likely that the business will be a mainstream contractor. However, if the business’ only core activity is the generation and sale of energy (for example, the sale of electricity from a solar farm), then the business might only be subject to the CIS as a deemed contractor if its annual expenditure on construction operations (for example, on construction of the solar farm) exceeds £3 million.

Even if a business is potentially subject to the CIS, one of the exemptions to the CIS may apply to payments made by it to subcontractors. For example, where a business is established to generate energy through, say, a ground mounted solar farm which it constructs and owns, then (provided it is not a mainstream contractor) the exemption referred to above might apply to any payments to a subcontractor for the construction of the solar farm.

Are there any other consequences of falling within the CIS?

Yes. Businesses involved in the construction operations of generation or storage assets may fall within the scope of the VAT Domestic Reverse Charge (Reverse Charge).

The Reverse Charge has been effective since March 2021 and must be used for most supplies of building and construction services (which are broadly the same as “construction operations” under the CIS).

The Reverse Charge applies to standard and reduced rate VAT services:

• for businesses who are registered for VAT in the UK; and
• reported within the CIS.

If the Reverse Charge applies, it reverses the usual VAT position so that the recipient of the construction services (i.e. the contractor for CIS purposes), and not the supplier (i.e. the subcontractor), is required to account for VAT on those services to HMRC.

As with the CIS, there are a number of exemptions which apply to the Reverse Charge including where the supplier and recipient are landlord and tenant.

TLT comment

The CIS and Reverse Charge are an additional administrative burden for businesses involved in construction operations and so the government is continuing to review further areas of simplification of the CIS. In the meantime, understanding when the CIS and Reverse Charge will apply to a business constructing or engaging the construction of generation or storage assets is crucial to ensure tax compliance.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at June 2024. Specific advice should be sought for specific cases. For more information see our terms & conditions.