Subcontracting for Tradespeople: CIS Responsibilities, Labour-Only Contracts, IR35 Risk and VAT on Labour

Summary

Subcontracting is fundamental to how construction works in the UK. Most domestic projects involve a main contractor (or a homeowner as the client) engaging specialist tradespeople as subcontractors. The legal, tax and commercial framework governing this relationship is more complex than many tradespeople realise, and errors create significant financial and legal risk.

The Construction Industry Scheme (CIS) is an HMRC scheme specifically designed for construction subcontracting. Its purpose is to prevent tax evasion by ensuring that subcontractors pay their taxes, by deducting a withholding tax from labour payments made to them. For many tradespeople, CIS deductions are a significant cash flow issue — and understanding how to get gross payment status is commercially important.

The VAT domestic reverse charge (DRC) adds another layer: since March 2021, VAT-registered contractors supplying construction services to other VAT-registered contractors must not charge VAT in the normal way. The VAT is accounted for by the recipient, not the supplier. Getting this wrong creates complications with HMRC.

Key Facts

• CIS (Construction Industry Scheme) — HMRC scheme requiring main contractors to make deductions from subcontractor payments; applies to construction work in the UK
• CIS scope — Applies to: site preparation, demolition, building, installation of systems (heating, plumbing, electrical), internal/external decoration, groundwork, roofing, scaffolding
• Excluded from CIS — Architecture and surveying fees; carpet laying (if supply-only); manufacturing/delivery of materials; direct employment (PAYE employees)
• CIS registration — Subcontractors must be registered with HMRC; standard registration = 20% deduction; unregistered = 30% deduction; gross payment status = 0% deduction
• Gross payment status — Granted by HMRC if you meet turnover test, compliance test, and business test; allows zero deductions
• Main contractor — Must verify all subcontractors with HMRC before making first payment; must file monthly CIS returns; must issue payment and deduction statements
• Labour-only — Payment for pure labour; full CIS deduction applies to entire payment
• Labour and materials — CIS deduction applies to labour element only; materials not subject to deduction (must be evidenced separately)
• Domestic reverse charge (DRC) — VAT accounting rule for B2B construction services from March 2021; applies when both parties are VAT-registered; recipient accounts for VAT rather than supplier
• DRC applies to — Services within CIS scope; where both parties are VAT-registered; not for end-user/consumer clients
• DRC does not apply — To final consumers (homeowners); where the customer is the end user; to employment businesses supplying staff

Quick Reference Table

Detailed Guidance

CIS: How It Works in Practice

Scenario: You are a self-employed plumber. A main contractor asks you to install central heating in a new-build. You agree £5,000 + VAT for labour and materials.

Step 1: Main contractor verifies you The main contractor logs into their CIS online service and verifies your UTR (Unique Taxpayer Reference) with HMRC. HMRC confirms your deduction rate (20% registered, 30% unregistered, 0% gross).

Step 2: You invoice the main contractor Break down your invoice into labour and materials:

• Labour: £2,500
• Materials: £2,500
• Total: £5,000
• VAT: If DRC applies (see below), state "Reverse Charge: Customer to account for VAT of £1,000"

Step 3: Main contractor pays If your deduction rate is 20%:

• Labour: £2,500 − 20% (£500) = £2,000 paid
• Materials: £2,500 paid in full (no CIS deduction on materials)
• Total paid to you: £4,500

Step 4: Main contractor files CIS return Main contractor files monthly return to HMRC reporting the £500 deduction made.

Step 5: You claim the deduction on your Self Assessment When you file your Self Assessment tax return, you claim the £500 deducted against your income tax liability. If you have paid more in CIS deductions than your actual tax bill, HMRC refunds the difference.

Common errors:

• Not separating labour and materials on invoices: main contractor may deduct 20% from the whole invoice including materials
• Not being CIS-registered: contractor deducts 30% (10% more than necessary)
• Claiming false materials to reduce deduction: HMRC investigates; potential fraud charges

Gross Payment Status

Gross payment status (GPS) means HMRC does not require the main contractor to make any CIS deduction from your payments. You receive the full amount and pay all your taxes directly via Self Assessment.

Eligibility tests (all three must pass):

1. Business test: You must be carrying out a business in the UK
2. Turnover test: Net construction turnover must be at least £30,000 for sole traders; £30,000 per director for companies (up to £100,000 minimum for multiple directors)
3. Compliance test: All tax returns filed; all taxes paid on time; no serious criminal convictions

Application: Online via HMRC CIS service; typically processed within 30 days.

Annual review: HMRC reviews GPS annually. If you miss a tax payment or filing deadline, GPS can be removed without warning — and the main contractor will start deducting at 20% from the next payment.

Commercial value of GPS: If you turn over £150,000 in labour annually and are on 20% deductions, HMRC holds £30,000 of your money until you file your tax return (potentially 18 months). GPS gives you that cash flow back. This is why GPS is valuable even if your marginal tax rate would be 20% anyway.

Labour-Only vs Labour and Materials

The distinction between labour-only and labour-and-materials contracts is crucial for CIS:

Labour-only contract: You supply your time and skill; the contractor supplies all materials. CIS deduction applies to 100% of your payment.

Labour and materials contract: You supply both. CIS deduction applies only to the labour element. You must be able to evidence the materials cost:

• Your own purchase invoices from suppliers
• NOT materials you sold from your own stock at a markup (the entire payment could be treated as labour by HMRC if you cannot evidence separately)

Practical advice: Get supplier invoices for all materials and attach them to your CIS invoice. This protects you and the main contractor from HMRC challenges. Pass-through materials at cost; apply markup as a separate line only if the contract is for supply and install with your mark-up disclosed.

IR35: When Subcontracting Becomes Employment

IR35 (the off-payroll working rules) applies where a worker's contract is through a limited company (or partnership), but the working arrangements are similar to employment.

Tests for IR35:

1. Substitution: Can you send someone else to do the work without client approval? A genuine contractor can substitute; an employee cannot.
2. Control: Does the client control how, when and where you work? High control points towards employment.
3. Mutuality of obligation: Is the client obliged to offer you work and are you obliged to accept? Employment implies mutual obligation.
4. Financial risk: Do you bear financial risk (warranty obligations, buying your own tools, risk of bad debt)? Genuine contractors take financial risk.
5. Part and parcel of the organisation: Are you integrated into the client's workforce (attending their meetings, using their branded uniform, having a company email address)?

For tradespeople: Most genuine trade subcontractors pass the IR35 tests easily:

• You bring your own tools and vehicle
• You can (in theory) send another qualified tradesperson
• You take on financial risk (your invoice may not be paid; you warranty your work)
• You work for multiple clients

Risk area: Tradespeople who work exclusively for one contractor over many months, at the contractor's direction, using the contractor's tools, may be at IR35 risk. HMRC could reclassify this as employment, requiring the contractor to pay PAYE and NICs on your earnings (backdated).

Off-payroll rules from April 2021 (medium and large businesses): For medium and large companies (more than 50 employees and £10.2M turnover), the responsibility to assess IR35 status shifted to the contractor, not the worker. If you work for a large main contractor as a limited company, they should issue you a Status Determination Statement (SDS). If they determine you are inside IR35, they must deduct PAYE.

Small businesses: The rules do not apply to small client businesses; the worker (you or your company) assesses IR35 status.

VAT Domestic Reverse Charge

The domestic reverse charge (DRC) fundamentally changed how VAT works for construction subcontractors since March 2021.

Standard VAT (pre-DRC):

• You charge VAT to the main contractor on your invoice
• You collect this VAT and pay it to HMRC
• The main contractor reclaims it as input VAT
• This created a VAT fraud risk (subcontractors collected but didn't remit VAT)

DRC (from March 2021):

• You do NOT charge VAT to the main contractor
• Your invoice states: "Domestic reverse charge applies — customer to account for VAT of £[amount]"
• The main contractor accounts for both output VAT (as if they paid it) and input VAT (and can reclaim it)
• Net effect on the main contractor: zero (output and input cancel)
• You do not collect or remit this VAT

When DRC applies:

• Both you and the main contractor are VAT-registered
• You are supplying services within CIS scope
• The main contractor is not the end user (they are selling on the service)

When DRC does NOT apply:

• Your customer is the final consumer (homeowner directly commissioning you)
• Your customer is not VAT-registered
• You are the end user (the main contractor billing the homeowner)

Common confusion: Main contractors who directly serve homeowners (end users) still charge normal VAT on their invoices to the homeowner. It is only the B2B subcontracting chain within VAT-registered contractors that uses DRC.

Invoice wording example (DRC applies): "Labour and materials — heating installation: £5,000
VAT: Domestic reverse charge — customer to account for VAT at 20% = £1,000
Total due: £5,000 (no VAT collected)"

Frequently Asked Questions

Do I need to be CIS-registered even if I only do one subcontract job a year?

Yes, if you are being paid for construction work by a contractor (not an end-user homeowner). The main contractor is legally required to make CIS deductions from your labour payments if you are not registered — at 30% if you are unregistered. Register with HMRC (free) to get the 20% rate, or apply for gross payment status if your turnover qualifies.

I work as a sole trader and pay my subbies cash. Do I need to register as a main contractor under CIS?

Yes. If you engage other construction workers as subcontractors and pay them for construction work, you are a main contractor under CIS regardless of your size. You must register as a main contractor with HMRC CIS, verify all subcontractors before paying them, make deductions at the correct rate, and file monthly CIS returns. Failing to do this can result in penalties equal to the deductions you should have made.

Can a homeowner use CIS when they employ a tradesperson directly?

No. CIS applies to businesses in the construction industry making payments to construction subcontractors. A private homeowner commissioning work on their own home is not a contractor under CIS. You simply invoice the homeowner at your normal rate including VAT (if you are VAT-registered) and pay tax via Self Assessment.

What is the difference between CIS and PAYE?

CIS is a tax deduction scheme for self-employed subcontractors; the deduction is a withholding against their expected tax liability, and they self-assess and pay the balance (or claim a refund). PAYE is for employees; the employer deducts income tax and National Insurance at source and remits to HMRC. A PAYE employee is entitled to employment rights (holiday pay, sick pay, minimum wage protections); a CIS subcontractor is not.

Regulations & Standards

• Finance Act 2004 — Established the Construction Industry Scheme in its current form

• SI 2005/2045 — Income Tax (Construction Industry Scheme) Regulations 2005

• IR35 (off-payroll working rules) — Chapter 10 ITEPA 2003; Finance Act 2021 changes for medium/large firms

• Value Added Tax (Reverse Charge) (Building and Construction Services) Regulations 2019 — Domestic reverse charge framework

• HMRC CIS Guidance — GOV.UK: Construction Industry Scheme — comprehensive HMRC guidance

• HMRC CIS Guide — HMRC's official CIS guidance

• HMRC Domestic Reverse Charge — Technical guide on DRC for construction

• HMRC Check Employment Status Tool (CEST) — HMRC's IR35 checking tool

• commercial jobs — Additional considerations when working on commercial properties

• part p notifications — Regulatory notifications relevant to subcontracted electrical work