CIS Payroll: How to Pay Subcontractors Under the Construction Industry Scheme

1. Introduction to the Construction Industry Scheme (CIS)

The Construction Industry Scheme (CIS) is a set of special rules for handling payments made by contractors to subcontractors for construction work in the UK. Established by HM Revenue & Customs (HMRC), its primary goal is to minimise tax evasion within the construction sector by ensuring that tax is deducted at source from payments made to subcontractors. This guide will walk you through the intricacies of CIS, helping both contractors and subcontractors navigate their obligations for the 2026/27 tax year.

Under CIS, contractors must deduct money from a subcontractor's payments and pay it directly to HMRC. These deductions count as advance payments towards the subcontractor's tax and National Insurance contributions. The scheme applies to most construction operations carried out in the UK, including site preparation, alterations, dismantling, construction, repairs, decorating, and demolition. It covers all types of businesses involved, from sole traders and partnerships to limited companies.

2. CIS vs. PAYE: Understanding the Difference

It's crucial to distinguish between the Construction Industry Scheme (CIS) and Pay As You Earn (PAYE), as they apply to different employment statuses and have distinct implications for tax and National Insurance. While both involve deductions at source, their application depends on whether an individual is considered an employee or a self-employed subcontractor.

The key differentiator lies in employment status. If an individual is genuinely self-employed, working under a contract for services, they fall under CIS. If they are an employee, working under a contract of service, they are subject to PAYE. Contractors must carefully assess the employment status of their workers to ensure compliance with the correct scheme.

3. Verifying Subcontractors with HMRC

Before making any payments to a new subcontractor, contractors are legally required to verify them with HMRC. This process determines the correct deduction rate to apply to their payments and ensures compliance with the CIS regulations. Failure to verify can lead to applying the higher deduction rate unnecessarily or, worse, penalties for non-compliance.

The Verification Process: Step-by-Step

1. Gather Subcontractor Details: Obtain the subcontractor's business name, Unique Taxpayer Reference (UTR), National Insurance number (for sole traders), and company registration number (for limited companies).
2. Access HMRC Online Service: Log in to the HMRC online service for CIS. Most accounting software with CIS modules (e.g., Sage, QuickBooks, Xero) integrate directly with HMRC for this purpose, streamlining the process.
3. Submit Verification Request: Enter the subcontractor's details. HMRC will then confirm their registration status and advise on the appropriate deduction rate.
4. Record Verification Details: Keep a record of the verification number provided by HMRC for your records. This number serves as proof of verification.

4. CIS Deduction Rates for 2026/27

The amount of tax a contractor deducts from a subcontractor's payment depends on the subcontractor's registration status with HMRC. For the 2026/27 tax year, there are three primary deduction rates:

Gross Payment Status (GPS) Explained

Subcontractors with Gross Payment Status (GPS) receive payments from contractors in full, without any deductions. This significantly improves cash flow for the subcontractor, as they don't have to wait to reclaim deductions from HMRC. To qualify for GPS, a subcontractor must meet strict criteria, including a good tax compliance history, a turnover test, and a business test. HMRC regularly reviews GPS status, and it can be revoked if compliance standards are not maintained.

5. The Monthly CIS Return Process

Contractors are responsible for submitting monthly CIS returns to HMRC, detailing all payments made to subcontractors within the scheme. This is a critical compliance requirement, and late or incorrect returns can lead to penalties.

Key Aspects of Monthly Returns:

• Reporting Period: Each return covers a tax month, which runs from the 6th of one month to the 5th of the next. For example, the tax month covering 6 April to 5 May must be reported by 19 May.
• Submission Deadline: The monthly CIS return must reach HMRC by the 19th of the month following the end of the tax month.
• Information Required: For each subcontractor, you must report their name, UTR, gross amount of payment, cost of materials (if any), and the amount of CIS deduction made.
• Nil Returns: If you haven't paid any subcontractors in a particular tax month, you still need to submit a 'nil' return to HMRC to confirm this. Many accounting software solutions can automate this.

6. Paying Subcontractors and Providing Deduction Statements

Once you've calculated the CIS deduction, you'll pay the subcontractor the net amount. Equally important is providing them with a deduction statement, which is a legal requirement and essential for the subcontractor to reconcile their tax affairs.

Calculating Net Payment:

The CIS deduction is applied only to the labour portion of the payment. You must subtract the cost of materials (and certain other expenses like plant hire) from the gross payment before calculating the deduction. For example:

• Gross Payment for work: £1,000
• Cost of Materials: £200
• Amount subject to CIS: £1,000 - £200 = £800
• CIS Deduction (20%): £800 * 0.20 = £160
• Net Payment to Subcontractor: £1,000 - £160 = £840

Deduction Statements:

You must provide each subcontractor with a written statement of all payments made and deductions taken within 14 days of the end of each tax month. This statement should include:

• Your (the contractor's) name and HMRC tax reference.
• The subcontractor's name and UTR.
• The gross amount of payment.
• The cost of materials (if applicable).
• The amount of CIS deduction.
• The net amount paid.

Many accounting software packages automate the generation and even distribution of these statements, saving significant administrative time.

7. Year-End CIS Reconciliation

While CIS operates on a monthly basis, there are year-end considerations for both contractors and subcontractors to ensure all tax affairs are in order.

For Contractors:

Contractors primarily ensure all monthly returns have been submitted accurately and on time. There isn't a separate year-end CIS return in the same way as PAYE. Instead, HMRC uses the cumulative monthly returns to assess your annual compliance. It's crucial to keep meticulous records throughout the year to facilitate any queries from HMRC.

For Limited Companies (Subcontractors):

Limited company subcontractors can set off the CIS deductions they suffer against their own PAYE, National Insurance Contributions (NICs), Student Loan repayments, and even CIS deductions they make from their own subcontractors. This is done monthly (or quarterly) via the Employer Payment Summary (EPS). If, at the end of the tax year, the company's CIS deductions exceed these liabilities, the excess can be refunded or set against Corporation Tax due. No in-year repayments are typically made unless the company is in liquidation or administration.

8. How Subcontractors Reclaim CIS Deductions

Subcontractors who have had CIS deductions made from their payments can reclaim these amounts. The method of reclamation depends on their business structure.

Sole Traders and Partnerships:

Individual subcontractors and partners in a partnership reclaim CIS deductions through their annual Self Assessment tax return. The deductions are treated as payments on account towards their overall tax and National Insurance liability. If the total CIS deductions exceed their final tax bill, HMRC will issue a refund.

Limited Companies:

As mentioned above, limited companies primarily set off CIS deductions against their PAYE, NICs, and Student Loan liabilities via the EPS. Any remaining excess deductions at the end of the tax year can be claimed back as a refund or offset against their Corporation Tax bill. It's important for limited companies to *not* try to reclaim CIS deductions through their Corporation Tax return directly if they have a PAYE scheme, as this can lead to errors and delays.

9. CIS Modules in Popular Accounting Software

Managing CIS manually can be time-consuming and prone to errors. Fortunately, most popular accounting software packages offer dedicated CIS modules or features that streamline compliance, from subcontractor verification to monthly return submissions and statement generation.

Utilising accounting software with robust CIS capabilities can significantly reduce the administrative burden and ensure ongoing compliance, allowing contractors to focus more on their core business activities.