On 19 October 2015, HMRC updated its Construction Industry Manual: Construction Industry Scheme Reform Manual CISR section 12080.
The update clarifies and updates guidance on the distinction between property investment and property development businesses. Essentially:
- Property developers are mainstream construction industry contractors because their business activity is the creation of new buildings, or renovation or conversion of existing buildings, or other civil engineering works.
- Property investors differ because they acquire and dispose of buildings for capital gains and or use the buildings for rental; they need not be involved in the construction, alteration or extension of buildings.
Needless to say HMRC is concerned and on the look-out for businesses that may cross over from investment to development and who should therefore be complying with the Construction Industry Tax Deduction Scheme (CIS). Additionally if a property investor’s portfolio or estate is substantial enough, the investor may incur a level of expenditure on alterations or extensions to existing buildings (i.e. construction operations), that may well cause the investor to fall within the meaning of a ‘deemed contractor’. Deemed contractors must also comply with CIS.
With many landlords and property investors potentially being affected, it is useful to review current legislation to help those with multiple properties or substantial estates to determine how their business might be viewed in the eyes of the taxman:
- Are your activities now of development rather than investment?
- Does your expenditure on investment properties exceed £1 million per annum averaged over a three year period?
If your investment empire is growing or you’re not sure where the land lies, this guide will help you to work out your position.
What are the possible implications?
The operational and administrative differences between property investment companies and property development companies are huge. The distinction affects the whole way your portfolio is geared and structured – particularly when it comes to tax.
If your property portfolio is currently classed as investment led, but the legislation defines you as a developer, the potential ramifications are huge. Beyond the additional administration, it would become necessary to register with HMRC as a contractor and operate the CIS.
This will mean having to deduct tax from certain payments made to sub-contractors i.e. businesses or individuals who have undertaken any construction work for you and submit monthly returns to HMRC.
Failure to do so could result in HMRC recovering from you not only any tax that should have been deducted from payments made to sub-contractors, but also charge you interest and various penalties not least for failing to submit monthly contractor returns. Penalties for late returns can escalate rapidly:
- One day late £100
- 2 months late £200
- 6 months late £300 or 5% of the CIS deductions on the return, whichever is higher
- 12 months late £300 or 5% of the CIS deductions on the return, whichever is higher.
- More than 12 months late up to a maximum £3,000 or 100% of the CIS deductions on the return, whichever is higher.
The penalties apply to each monthly return so if you have failed to submit returns for the past 12 months the penalties could be significant.
Under what circumstances might a business be reclassified?
Businesses that are not obvious or historical mainstream construction contractors are still at risk of becoming a mainstream contractor by virtue of the activities being carried out or being deemed to be a contractor by virtue of the level of expenditure incurred on construction operations. Landlords with large portfolios that undertake several concurrent renovations are typical examples.
- A property investment business enters into multiple or substantial contracts relating to construction operations for the purposes of development of one or more properties, HMRC will more than likely decide that the business has changed from “property investor” to “property developer”, in which case that business would be considered to be mainstream contractor.
- A property investment business acquires a large dilapidated hotel to add to its portfolio, and decides to convert the building into a series of flats which it will then individually let out. As a result, substantial development is required to the property to change the building to its new use. In respect of this particular development and contract HMRC would regard the property investment business as having taken on the mantle of a mainstream contractor (as opposed to being a deemed contractor) as its business activity is now that of construction operations.
With regards to being “deemed” to be contractor, Section 59 (1) (l) Finance Act 2004 provides that a business that does not ordinarily do construction work will become a contractor if it spends an average of £1 million or more per annum in any three year period on construction operations.
A property investment business acquires a number of properties which it intends to let, but before letting, minor refurbishment is required to bring the properties up to a suitable standard to be able to let them. For CIS purposes HMRC see this as the normal activities of a property investor, however where the average annual expenditure on such activities exceeds the aforesaid £1m per annum average, then the investor will be a “deemed “ contractor and will need to register with HMRC for CIS.
What is the driver behind the updated guidance?
HMRC has highlighted the possibility that certain property investment businesses may have “crossed the line” and undertaken activities that are more akin to property development than property investment. The implication is that the activities fall within mainstream construction and that businesses will be required to register with HMRC as a contractor and comply with the CIS.
HMRC has dedicated Construction Industry teams that will be monitoring current property investment businesses with a view to undertaking “compliance checks” to ascertain whether any property investment business has “crossed the line”. The result for business could be an unexpected and un-budgeted tax bill.
Are there any reliefs?
Fortunately there is some relief but only for deemed contractors i.e. non-mainstream construction businesses. Investment businesses brought into the scheme because their average expenditure on construction projects exceeds £1 million per annum over any three year period, can apply to HMRC not to have to apply the CIS to construction expenditure that relates to property used for their own business or company purposes.
Typically this applies to properties such as offices, warehouses and nursing homes, this is commonly referred to as “own build”. However, the property is not used for the purpose of the business of a person if it is for sale or “let” (except where the expenditure is purely incidental) or is held as an investment by that person. Also note, it is the payment that is exempted from CIS not the business or the actual construction contract.
Even if payments relate to “own build” properties, registration with HMRC as a contractor is still required, but payments to the sub-contractors can be exempted from CIS. If all the payments relate to “own build” then an application can be made to HMRC to de-register from CIS. In other words you have to join the club in order to de-register. Please be aware that a failure to register with HMRC even though all the payments relate to “own build” will give rise to penalties for failing to submit monthly contractor returns and comply with CIS.
What are HMRC’s CIS team focussing on?
In addition to the above, HMRC’s CIS teams are focusing on the split between materials and labour. HMRC’s findings are that businesses are not always correctly identifying the cost of a sub contractor’s materials and are simply using supposedly “industry norms” as a means of establishing the taxable labour element e.g. 60% materials, 40% labour, thereby only taxing 40% of the overall contract costs.
This is clearly incorrect and HMRC is insisting that in accordance with the legislation, the full payment to the subcontractor must be taxed unless the subcontractor can provide third party evidence to support the cost of materials used on the job. This is not always easy to obtain such information from subcontractors but the onus is on the contractor to make every effort to obtain the details otherwise by failing to comply with the rules and simply using industry norms contractors will be exposed to additional liabilities in respect of tax they should have deducted from the payments, interest and penalties.
What do I need to do if my letting or investment portfolio might be affected?
Landlords and investors that are unsure if they are affected by the rules should seek professional advice. Always ensure that you and your advisors monitor the actual activities that you are undertaking in case they are mainstream construction and also, if you are not a mainstream contractor, whether your average expenditure on construction including labour and materials exceed on average £1 million per annum over any three year period. It is also advisable to maintain a long-term assessment of your contractor status based on pipeline projects.
Thank you for reading!
My name is Gary Cryer and I am a senior tax consultant at OneE Group. We are a tax advice and tax planning specialist that works with landlords throughout the UK and are an accredited partner of the NLA.
I hope you found this post useful in helping to establish whether your lettings or investment portfolio could be reclassified to the extent that you should be registered with HMRC as a contractor within CIS.