The Construction Industry Scheme is one of those areas of UK tax that catches people out. It looks simple on the surface: you hire a subcontractor, you deduct tax from their payment, you send it to HMRC. But in practice, CIS payroll involves verification checks, monthly returns, multiple deduction rates, material cost exclusions, and penalty triggers that can easily trip up a busy contractor who’s trying to run a building site rather than an accounts department.
This guide covers how CIS works in practice, from registration through to monthly filing, with particular focus on the areas where contractors and subcontractors get into trouble.
How CIS works: the basics
CIS applies to payments made by contractors to subcontractors for construction work carried out in the UK. The contractor deducts tax at source from the labour element of each payment and sends that deduction to HMRC. The deduction counts as an advance payment towards the subcontractor’s Income Tax and National Insurance liability for the year.
The scheme covers most types of construction work: building, demolition, repairs, alterations, decorating, civil engineering, and installation of heating, lighting, power, and similar systems. It doesn’t cover architecture, surveying, scaffolding hire without labour, or carpet fitting.
You’re a contractor under CIS if you pay subcontractors for construction work. A business outside construction can also become a deemed contractor when its construction expenditure exceeds £3 million in a rolling 12-month period. Local authorities, housing associations, and government departments are all deemed contractors regardless of spend.
Registration: both sides need to act
All contractors must register with HMRC for CIS before they engage their first subcontractor. You’ll need to register as an employer first, then add CIS registration through HMRC’s online service.
Subcontractors don’t have to register, but there’s a very strong financial reason to do so. If a subcontractor is registered, the deduction rate is 20%. If they’re not registered, it jumps to 30%. That’s a significant cash flow difference on every payment throughout the year. And for subcontractors who meet HMRC’s qualifying criteria (including a turnover test starting at £30,000 for sole traders), gross payment status means 0% deductions, with the full payment received and the subcontractor settling their own tax bill via Self Assessment.
So the three deduction rates are: 0% for gross payment status holders, 20% for registered subcontractors, and 30% for unregistered subcontractors.
Verifying your subcontractors
Before making a first payment to any subcontractor, you must verify them with HMRC. This is non negotiable. You can do it through HMRC’s online CIS service or through commercial CIS software (which is mandatory if you’re verifying 50 or more subcontractors). HMRC will confirm whether the subcontractor is registered and tell you which deduction rate to apply. You’ll receive a verification number that you should keep on file. If you want to outsource CIS payroll to specialists, a bureau handles this entire verification process as part of the service.
You need to verify each subcontractor the first time you pay them, or if there’s been a gap of more than two tax years since the last payment. If you’ve paid the same subcontractor continuously, you don’t need to re verify each time.
Calculating and making deductions
CIS deductions apply only to the labour portion of the payment. The cost of materials that the subcontractor has directly incurred to fulfil the contract is excluded. So if a subcontractor invoices you £5,000 and £1,500 of that covers materials they purchased, you apply the deduction rate to £3,500, not the full invoice.
Worked example: A registered subcontractor invoices you £4,000 for a job. Of that, £1,000 is materials. The deductible amount is £3,000. At the 20% rate, you deduct £600 and send it to HMRC. The subcontractor receives £3,400 (£4,000 minus £600).
After making each payment, you must provide the subcontractor with a written payment and deduction statement within 14 days of the end of each tax month. This statement needs to show the gross amount, the cost of materials, the amount of the deduction, and the net payment.
Monthly CIS returns
Every month, you must file a CIS return with HMRC by the 19th of the following month. This covers all payments made to subcontractors during the tax month (which runs from the 6th of one month to the 5th of the next). If you have told HMRC that no subcontractor payments will be made for up to six months, a nil return is not required for those months; otherwise file the required monthly return.
Late filing penalties start at £100 for the first month and escalate from there. Miss three months and you’re looking at £300. After 12 months, HMRC can charge the greater of £300 or 5% of the total CIS deductions that should have been reported. These penalties are per return, so if you’re consistently late, they add up fast.
CIS deductions must be paid to HMRC by the 19th of the month following the tax month (or the 22nd if paying electronically). This is the same deadline as your PAYE payment, and in practice most contractors pay both together.
Limited company subcontractors: offsetting CIS against PAYE
This is the area where things get more complex. If a subcontractor operates through a limited company, any CIS deductions they suffer can be offset against their PAYE liabilities. The process works through Real Time Information: the company submits its Full Payment Submission (FPS) as normal, then submits an Employer Payment Summary (EPS) showing the total CIS deductions for the year to date. HMRC offsets the CIS deductions against the PAYE and NIC owed, and the company only pays the balance. For more detail on how PAYE and CIS interact, take a look at the benefits of using a payroll bureau to keep both systems aligned.
If the CIS deductions exceed the PAYE liability, the company can reclaim the excess from HMRC. This can be done online or by post, but you’ll need accurate records of all CIS deductions suffered and your payroll submissions need to match up. Discrepancies between the CIS deductions claimed on EPS and what HMRC’s records show will delay any refund and may trigger a compliance check.
VAT reverse charge for construction
Since March 2021, the domestic VAT reverse charge applies to most CIS transactions between VAT registered businesses. Under the reverse charge, the subcontractor does not charge VAT on their invoice; instead, the contractor accounts for the VAT through their own VAT return. This only applies where both parties are VAT registered and the payment is reported under CIS.
The reverse charge doesn’t change the CIS deduction calculation itself (you still apply 0%, 20%, or 30% to the labour element), but it does change the cash flow dynamics significantly. Subcontractors no longer collect VAT from contractors, which can create a cash flow squeeze, particularly in the early months of trading.
HMRC’s tightening grip on CIS compliance
HMRC has been steadily tightening CIS enforcement. From April 2021, new rules gave HMRC the power to amend CIS deduction amounts claimed by subcontractors on their EPS returns if satisfactory evidence isn’t provided. From April 2026, further anti fraud measures take effect, giving HMRC stronger powers where businesses knew or should have known that a payment was connected to tax evasion.
The deemed contractor threshold also changed, requiring businesses to monitor their construction expenditure more regularly. If your non construction business tips over £3 million in construction spending within the previous 12 months, you become a deemed contractor and need to apply CIS to all future construction payments.
CIS payroll is one of those things that’s perfectly manageable if you stay on top of it, but quickly becomes a problem if you fall behind. Monthly returns, verification checks, deduction calculations, material cost exclusions, and the interaction with PAYE and VAT all need to work together. For construction businesses across Hull and East Yorkshire, having a specialist handle the CIS side of things means you can focus on the actual building work. Check our payroll pricing for your business or get in touch to discuss how we can take CIS payroll off your hands.
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