CIS Retentions
Retentions within the construction industry refer to a portion of the payment that is withheld by the contractor from the subcontractor until the completion of the project or until certain conditions are met. This practice is intended to ensure that subcontractors complete their work to the required standards and rectify any issues that may arise post-completion.
CIS Treatment of Retentions
Under CIS, the tax treatment of retentions is straightforward:
- Tax Deductions: The amount of CIS tax deducted is based on the payment that is actually made, not on the full invoice amount. Therefore, the retention amount is excluded from the CIS tax calculation until it is paid.
- Timing of Deduction: The key aspect of retention under CIS is that the tax deduction is made at the time of payment. Therefore, even if the work was completed much earlier, the CIS tax is deducted when the retention payment is actually made, reflecting the subcontractor’s tax status at that time.
How Retentions Affect Cash Flow
For subcontractors, retentions can significantly impact cash flow, as a portion of their income is deferred. Managing these delays requires careful financial planning to ensure that ongoing operational costs can be met, even when a substantial part of the payment is held back.
When should CIS be taken off a Retention?
Retention payments in the construction industry are subject to the same rules as other types of payments. The key factor determining how a retention payment is processed – either as a gross payment or with deductions – is the subcontractor’s tax status at the time the payment is made, not at the time the work was completed.
Contractors need to verify the subcontractor’s current tax status inline with paragraphs 3.1 to 3.9 of the HMRC guidance before making any deductions under CIS. The CIS does not differentiate between types of payments, such as retentions or other project-specific payments; it uniformly applies to all payments.
Subcontractors’ tax status may change over the period during which retention is held. Failing to re-verify a subcontractor’s status before making a retention payment is likely not considered a valid excuse, as outlined in paragraph 3.9 of the HMRC guidance, which can be found here: HMRC guidance on CIS.
Managing CIS Retentions Effectively
- Clear Agreements: Ensure that your contracts clearly state the terms for retentions, including the percentage to be retained and the conditions for release. This clarity can help manage expectations and reduce disputes.
- Accurate Record-Keeping: Maintain detailed records of all contracts and retention amounts. This documentation will be crucial for financial planning and for supporting any disputes or negotiations regarding delayed payments.
- Regular Follow-ups: Once the conditions for retention release are satisfied, follow up promptly with contractors to secure the release of retained funds. Delays in following up can further impact your cash flow.
- Financial Buffering: Plan for delays in retention payments by establishing a financial buffer. This can help manage the impact of delayed payments on your day-to-day operations.
Legal Considerations
It’s important to understand that while CIS regulates tax deductions on payments, the contractual aspects of retentions are governed by the terms of the contract between the contractor and the subcontractor. Contractors must treat retention payments fairly and release them promptly once the contractual obligations are fulfilled.
Fictional Company Example
For those sub-contractors who are paid after deduction of tax, the following example of a remittance advice (which the contractor may provide as a substitute for a deduction statement) may be of use:
Example:
- Business Name: A Contractor Ltd.
- PAYE Reference: 123/AB12345.
- Payment Date: Payment on 5 February 2022.
- Payment Recipient: Paid to “A Sub-contractor Ltd”, UTR 12345 67890.
- Payment For: Work on the ABC project, Gloshampton.
| £ | ||
| Gross payment: | Labour | 20,000 |
| Materials | 15,000 | |
| 35,000 | ||
| Retention @ 5% | (1,750) | |
| Subtotal | 33,250 | |
| VAT @ 20% | 6,650 | |
| CIS tax deducted | (3,800) | |
| Payment to account 88-77-66 55443322 | 36,100 |
The CIS tax deducted at the standard rate of 20% is calculated on the labour element of the payment, after deduction of the 5% retention withheld by the contractor. 20% of £20,000 less the 5% retention gives £3,800.
Payment is calculated on the value paid to the sub-contractor. An application for payment or an invoice may be issued to the contractor, but it is the sum authorised for payment which counts for CIS. The only exception to this is a deduction made from the sub-contractor in respect of a CITB levy.
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