Introduction
The construction industry is unique in that contractors and subcontractors must grapple with the often confusing Construction Industry Scheme (CIS). Under this scheme, various obligations, including registration and tax deduction from payments, come into play.
But before you dive into the intricacies and try to decipher the government's explanation of the CIS, why not continue reading our blog post? We'll cover the most crucial aspects of the scheme in a manner that is as clear as possible for you to comprehend.
Let’s get straight to it.
Accounting basics for construction businesses
In essence, accounting in the construction industry follows the same principles as accounting for any other type of business.
Like other industries, you’ll need to follow the UK generally accepted accounting practice (GAAP) standards when recording and reporting your financial information.
You’ll need to follow best practices for:
maintaining regular and accurate records of your income and expenses
organising and summarising your financial information
reporting to HMRC and Companies House as required.
Unique accounting challenges for construction businesses
The construction industry also comes with its own unique accounting challenges and specific regulations that you need to familiarise yourself with when operating in this pace.
Here are a few of the ways construction accounting is different to other types of accounting.
Accounting for projects
One of the defining features of construction industry work is that it’s generally project-based. You might have multiple projects running at the same time, with changeable timelines and different income and expenses applying to each.
Keeping separate records and calculating your profit and loss for each individual project will allow you to accurately monitor cashflow and stay on budget, making sure you have full visibility on how profitable each project is.
You’ll also need to effectively estimate costs for each construction project, keeping detailed and up-to-date records at both a project and business level. And you’ll need to be prepared to handle unpredictable cashflow and sudden changes to project plans.
Cashflow challenges
Construction is often a high-cost, low-margin business, which means without proper management, any disruption to cashflow can potentially be disastrous.
Unfortunately, unpredictable cashflow is also common in this sector. You might be paid up-front for a project or after completion, or your client might pay you weeks or months later than they agreed. The scope or duration of a project might shift over time, leading to fluctuations in costs. This, in turn, can hamper your ability to pay your own suppliers and contractors.
Your payroll is also likely to be more subject to change than businesses with regular staff – it might vary from week to week if you employ contractors and temporary workers.
To minimise the impact on your construction business, you’ll need to allow for those changes within your contracts, document all change orders throughout a project and make sure you have full visibility on what these variables mean for your costing.
Compliance requirements
There are several sector-specific compliance requirements within the construction industry, including building regulations, health and safety, employment law, and anti-corruption and fraud measures.
You’ll also need to follow various rules when it comes to tax. Historically, cash-in-hand work has been prevalent in the industry, leading to anti-evasion measures such as the construction industry scheme (CIS) and domestic VAT reverse charge.
If you work with subcontractors, or you’re a contractor yourself, you might also be affected by the off-payroll working rules, otherwise known as IR35.
It’s important to understand your obligations under these schemes so you don’t fall foul of the rules and incur penalties as a result.
Tax in the construction industry
Business owners in the construction industry will need to have a general understanding of tax to meet their obligations, as well as knowledge of specific requirements for the industry.
The construction industry scheme
What is the CIS?
The CIS is an HMRC scheme which applies to payments to subcontractors in the construction industry.
If you’re a contractor working with subcontractors, you’ll need to register with the scheme and deduct money from your subcontractors’ payments to pass on to HMRC.
Who is included under CIS?
You’re classed as a contractor under CIS if you:
• pay subcontractors for construction work (for example as a builder, labour agency, property developer, etc).
• are ‘deemed’ by HMRC to be a contractor.
If your business does not do construction work, you may still be deemed as a contractor if you have spent more than £3 million on construction in the 12 months since you made your first payment. (Housing associations, local authorities and government departments can fall under this category.)
There are exceptions to CIS for certain contracts and certain types of construction work.
You can find out more in the Government’s CIS guide for contractors and subcontractors.
What do you need to do?
If you’re a CIS contractor, you’ll need to register with HMRC.
You’ll then need to meet the following requirements:
Verify subcontractors with HMRC. You’ll need to verify subcontractors, either through the CIS online service or by using software before you can pay them. HMRC will tell you whether the subcontractor is CIS-registered, and what rate of deduction you should use.
File monthly returns. You also need to report the payments you’ve made each month. Again, this can be done through the CIS online service or by using HMRC-approved software.
These returns are due by the 19th of every month.
Make deductions. When you pay subcontractors, you’ll need to make deductions at a rate of 20% for subcontractors registered under the scheme, at 30% for those who aren’t registered, or at 0% if they have gross payment status.
Pass on the amount deducted to HMRC. After making your deductions, you’ll need to pass them on to HMRC. This payment is due by the 22nd of each month, or the 19th if you’re paying by post.
Keep records. Make sure you keep ongoing records of each payment invoiced by subcontractors (excluding VAT) and any deductions you’ve made. You’ll need to retain these records for at least three years following the end of the tax year
VAT for construction businesses
VAT is one of the main taxes to be aware of in the construction industry, and it can be complex to manage.
You need to register for VAT if your taxable turnover is more than £85,000 in any 12 months. It’s charged at three different rates:
standard rate: 20%
reduced rate: 5%
zero rate: 0%
Some goods and services are exempt from VAT altogether (this is different to being zero-rated).
Most building work on houses and flats is charged at the standard rate, although there are some exceptions where a reduced rate, zero rate or exemption might apply.
You can find detailed information on the VAT applicable to building and construction materials in HMRC’s VAT notice for contractors, subcontractors and developers.
The domestic reverse VAT charge for construction
The domestic reverse VAT charge came into effect for UK based construction businesses in March 2021.
This measure is designed to combat ‘missing trader’ fraud, where a business charges VAT but keeps the money instead of paying it to the tax authority.
Instead of the supplier accounting for and paying VAT to HMRC in the usual way, the reverse charge requires the business accessing the services to do so.
The charge applies to most standard and reduced rate VAT services that are reported within the CIS and supplied to a VAT registered business in the UK.
If you supply services included under the reverse charge, you do not need to charge VAT when issuing an invoice for those services. Instead, you’ll need to specify that the reverse charge applies.
The business receiving the services will then need to account for the VAT as output tax and pay it to HMRC. They can then reclaim the amount as input tax.
R&D relief
It’s also possible to claim tax relief if you’re carrying out innovative research and development (R&D) work.
There are two R&D schemes which offer corporation tax relief for UK businesses: the SME R&D scheme, and the research and development expenditure credit (RDEC).
To qualify, you’ll need to be able to show how your project looked for an advance in science or technology, and that you had to overcome a technological uncertainty that couldn’t be worked out by a professional in the field.
Construction tax reliefs and expenses
There are a wide range of reliefs and allowances available to help construction businesses reduce their tax liabilities, from claiming allowable expenses for day-to-day costs to incentives for investment in equipment and machinery.
Planning for these and making sure you’re not missing out on the reliefs available to you, is an important part of managing your business’s finances.
Allowable expenses
You can deduct many of your business’s day-to-day running costs from your profits before tax, resulting in a lower tax bill.
The general guideline is that these must be incurred ‘wholly and exclusively’ for the purposes of your business in order to qualify. Tools, safety equipment, uniforms and more could count as allowable expenses for construction businesses.
Capital allowances for plant and machinery
For purchases of equipment and machinery that you’ll use in your business for a longer term, you can claim relief via capital allowances.
The following capital allowances are available for plant and machinery:
The annual investment allowance (AIA): you can deduct the full value of qualifying items up to an allowance of £1 million.
100% first-year allowances: these allow you to claim the full cost of certain plant and machinery in the year of purchase.
The super-deduction or 50% special rate first-year allowance: these schemes were available for qualifying plants and machinery bought between 1 April 2021 and 31 March 2023.
Writing-down allowances: if you don’t qualify for the AIA, you can claim these to deduct a percentage of the value of qualifying plant and machinery from your profits.
Structures and buildings allowance
If you pay towards the purchase, construction or renovation of a non-residential structure, you might be eligible for tax relief under the structures and buildings allowance.
At its current rates, this allows you to deduct 3% per year over an allowance period of 33 and ⅓ years for qualifying expenditure.
You can claim this relief as long as all construction contracts were signed on or after 29 October 2018, and the structure meets the following conditions:
it was not used as a residence the first time it was used or during the period you’re claiming for
it is used for a ‘qualifying activity’, including:
any trades, professions and vocations
a UK or overseas property business (except for residential and furnished holiday lettings)
managing the investments of a company
mining, quarrying, fishing and other land-based trades such as running railways and toll roads
it has an allowance statement, which contains specific information about the structure.
Financial management for construction businesses
With fluctuating costs, project delays and contractual disputes all creating uncertainty for your construction business, an effective financial management system is essential.
This system should include detailed budgets, forecasts and processes to manage the potential risks involved.
Budgeting
For every project, you’ll need a detailed budget. This starts with extensive cost estimation.
A common accounting technique in the construction industry is job costing. Begin by breaking down each project into specific tasks – or ‘jobs’ – and allocate costs, taking into account labour, materials and overheads.
By going into granular detail at this stage, you can minimise the risk of exceeding your budget, manage cashflow more effectively, and allocate resources in the most efficient way.
Once you’ve made your estimates, be sure to regularly compare them with your actual expenses over time. This will help you to identify any over or under-estimates in the budget, allowing you to make corrections as you go.
Forecasting
Predicting future income is just as important as estimating costs.
You can use the data you’ve collected so far about current and past projects, as well as market trends and economic conditions, to draw up a realistic projection for the future.
By setting out key milestones in your project and forecasting your inflows, outflows and overall cash balance at each of those points, you can create a detailed cashflow forecast.
It’s important to monitor your forecast consistently throughout the project to identify any potential bottlenecks and make sure you’re always able to cover operational costs.
Billing and invoicing
Prompt and effective billing and invoicing are key to keeping the cash flowing in your business.
To start with, make sure your payment terms to clients are crystal clear. Then issue accurate, timely invoices that make it as easy as possible for customers to pay you, and follow up to chase any late payments. (Accounting software can take care of this for you, so it doesn’t have to be a drain on your time.)
Make sure you’re also paying suppliers and subcontractors promptly and accurately. By maintaining positive relationships across your supply chain, you’ll have a greater chance of adjusting your payment terms should you need to, or even accessing supplier discounts for prompt payment.
Contingency planning and risk management
Uncertainty is inherent in construction, but there are contingency plans you can put in place. Many firms set aside a portion of their budget, for example, to manage unforeseen costs – some recommend around 5-10%.
Using your financial forecasts, you can also carry out scenario and sensitivity analyses to judge the impact of potential problems on your business.
A scenario analysis involves adjusting different factors in your forecast to show how different factors would impact your finances. This could consider fluctuations in the price of materials, for example, or different labour costs. It’s common to draw up at least three scenarios: a best case, a worst case,
and somewhere in between.
Once you know what would happen in the worst-case scenario, you can come up with strategies to mitigate those problems.
A sensitivity analysis, meanwhile, involves identifying the variables that could have the biggest impact on the project’s financial outcome. By understanding which elements are most sensitive to change, you can focus your attention on managing those particular aspects.
Accounting software for construction
From meeting compliance requirements to managing your finances, software can help with various accounting tasks for construction businesses. Cloud accounting is quick and efficient, giving you more time to focus on the tasks that are important to your firm.
Plus, the Government’s Making Tax Digital scheme is requiring more businesses to maintain digital records and file online. It’s already a legal requirement for VAT-registered businesses to follow the scheme and, in the next few years, the same rules are due to apply to income tax and eventually corporation tax.
Using online accounting software is the fastest way to comply with these rules – and it can make your life much easier at the same time.
What do you need from construction accounting software?
Before choosing your software, it’s a good idea to assess the different features and capabilities you’ll need from it. Here are some examples of valuable software features for construction businesses:
• Project accounting: track time and costs across individual projects.
• Job costing: allocate and track costs for individual tasks.
• CIS compliance: meet the requirements of the CIS by filing a CIS300 return.
• Domestic VAT reverse charge: process tax rates under the reverse charge and include a disclaimer for it in invoices.
• Work on the go: cloud accounting tools offer access from any device, while many include a mobile app to make on the-go accounting easier.
• Online invoicing: automatically create and send invoices, sometimes with online payment options for your customers.
Many major accounting software providers offer construction-specific features, or you might choose to use a platform that’s specially built for your sector.
Get specialist accounting support
Given the complexity of construction projects, it can be overwhelming to manage accounting for them yourself.
Even with software to make things simpler, you still need a strong understanding of best practices and processes to stay on top of your finances, as well as the industry rules and regulations surrounding them.
As experts in construction accounting, we’ve been working with businesses like yours for years, helping them take advantage of the exciting opportunities this sector holds, without their accounting obligations holding them back.
We can help with:
• Tax: complying with the CIS, domestic reverse VAT charge and other tax requirements, as well as advice on operating tax-efficiently.
• Accounting: from statutory annual accounts and sell assessment returns to in-depth management accounts.
• Corporate finance: strategic advice on everything from mergers and acquisitions to planning your exit from the business.
• Payroll: including managing payments to subcontractors.
• Technology: adopting and making the most of cloud accounting software.
And if you want comprehensive support across all of these areas without the restrictions of hiring in-house, our virtual
finance office combines expertise and flexibility to give you all the finance services you need.
Find out more about our accounting services for construction businesses, or get in touch to talk about how we can help you.