It’s very likely your status as a taxpayer will change several times throughout your working life. As an employee, having tax deducted at source through PAYE makes your tax affairs relatively straightforward. But when your entrepreneurial spirit drives you to set out on your own, and you become responsible for reporting income and paying tax yourself, things become a little more complex.
Depending on whether you decide to operate your business as a sole trader, a partnership, or a limited company, the way your tax is calculated, how you pay it and when it’s due for payment will be different. And as your business evolves, you may well opt to move between models to suit your changing needs and optimise your tax efficiency.
In this blog, part of a series looking at the essentials of how tax works in different business models, we consider tax from the perspective of a sole trader working in the construction sector.
Over the next few months, we’re going to look at the essentials of how tax works in different business models. In this blog, we start by considering tax from the perspective of a sole trader.
Sole Trader in Construction: Overview
In most respects, the legal status and responsibilities of a sole trader working in the construction sector are the same as a sole trader operating in any other area of business. To find out how you remunerate yourself as a sole trader, how tax is calculated, which aspects of tax can catch out the newly self-employed, what kind of expenses can be set against income – and more, read our blog post Tax Essentials #1: The Sole Trader.
But there is an important distinction between sole traders whose customers are end-users, e.g. homeowners or landlords, and sole traders whose customers are – either wholly or in part – other construction businesses. While the former is – in all aspects, including tax – treated the same as any other self-employed individual, the latter – called subcontractors – are treated quite differently regarding how they’re taxed.
How & when do you pay your tax?
If you’re a sole trader planning to provide your services to builders or other organisations in the building industry, you must register with HMRC as a subcontractor under the Construction Industry Scheme (CIS).
Like anyone who is self-employed, you must complete and return an online Self-Assessment tax return to HMRC by midnight on 31st January following the end of the tax year – also the date by which you’ll have to settle your tax bill.
The big difference for you if you are a subcontractor is that when you submit your tax return, some of the tax you owe will already have been deducted by the contractors you’ve been working for – particularly if what you provide is predominantly or wholly your labour
How does CIS work?
- Registering onto CIS
Whilst you don’t have to be CIS registered if you’re a subcontractor, reputable contractors are unlikely to engage you, and HMRC will calculate deductions from your payments at a higher rate. If you have a UTR (Unique Tax Reference), you can register for CIS online or call the CIS helpline.
- Getting paid
When you work for a contractor, they’ll check you’re registered on the CIS scheme as a subcontractor. If you are, each time they pay you, they’ll deduct 20% of what you’re owed and pay this direct to HMRC. These deductions count as advance payments towards your tax and National Insurance bill, and the contractor will provide you with monthly statements as evidence of your deductions. They won’t make deductions for certain items you may include on your invoices, such as VAT and materials.
If you’re not CIS registered, the amount the contractor must deduct increases to 30%.
If you don’t want deductions made by contractors, you may be able to apply to receive gross payments, but you’ll need to have a turnover of at least £30k (excluding VAT and the cost of materials) and be able to meet a range of other criteria.
- Paying tax & claiming back deductions
As a CIS registered subcontractor, you’re still responsible for paying the correct tax and National Insurance for your business. When you file your Self Assessment tax return, in addition to your income, you’ll need to record any deductions contractors have made. HMRC will check the information you supply against that provided by the contractors you’ve been paid by to determine how much tax you owe.
If all or most of your work has been undertaken as a subcontractor and you’ve been deducted tax at 20% over the year, it’s quite likely you’ll be due a refund as your annual Tax-Free Allowance and tax-deductible costs, e.g. travel, tools and accounts fees, won’t have been taken into account. For this reason, it makes good sense to submit your tax return as early as possible.
Only if you’re income is particularly high, or you’re supplementing your subcontractor work with direct projects where CIS is not deducted are you likely to end the year in a position where you owe tax to HMRC.
It’s worth noting that you can be a subcontractor and a main contractor at the same time. A self-employed subcontractor may find themselves taking on bigger projects and needing to employ other subcontractors to help them. Because they’re used to working as a sole trader, they might be reluctant to incorporate the business and change its status to a limited company.
If you do operate as both a subcontractor and a main contractor (in whole or part), you’ll need to make CIS deductions for any subcontractors you employ and pay this money to HMRC. Setting up and operating CIS adds a layer of complexity and is not to be undertaken lightly. Your business will be required to submit monthly CIS returns – even for months when you may not employ any subcontractors, or you’ll be fined by HMRC.
What records do you need to keep?
When you run your own business, you’re required by law to securely retain financial records in case HMRC should decide to take a closer look at your affairs. If you’re a sole trader, you must retain your financial records for at least five years beyond your next tax filing deadline.
For subcontractors, it’s especially important to keep your CIS statements as evidence of payments deducted at source by contractors. Money deducted in this way will be allocated against your record by HMRC. At the end of each tax year, this ‘pot’ of money will be matched against your statements, and if there is any discrepancy, HMRC may require you to produce them.
At Inca, we specialise in supporting start-ups and small businesses. Many of the sole traders we work with are in the construction industry, so we understand CIS inside out.
If you’re self-employed and providing – or planning to provide, your services to contractors in the construction sector, Inca can help and advise you on all matters relating to tax and CIS. Whether your business is established, newly set up, or you’re still in the planning stages, we can advise on anything tax, finance or accounts related.