A contractor’s failure to deduct CIS tax turns the subcontractor’s tax bill into the contractor’s own liability. HMRC can issue a formal determination under Regulation 13 of the CIS Regulations 2005 requiring the contractor to pay over the amount that should have been withheld, even though the full payment has already gone to the subcontractor.1HM Revenue & Customs. Construction Industry Scheme Reform Manual – CISR82010 – Regulation 13 Determinations Introduction Penalties and interest sit on top of that, and gross payment status can be lost. There is a narrow relief route, and acting before HMRC opens an investigation makes a real difference to the final bill.
What HMRC Can Recover From You
The core obligation lives in Section 61 of the Finance Act 2004: a contractor must deduct a set percentage from the labour portion of any payment for construction operations and pay it to HMRC.2Legislation.gov.uk. Finance Act 2004 Section 61 When that does not happen, HMRC uses a Regulation 13 determination to collect the missing amount from the contractor directly.1HM Revenue & Customs. Construction Industry Scheme Reform Manual – CISR82010 – Regulation 13 Determinations Introduction
The rate HMRC applies depends on the subcontractor’s status. Registered subcontractors carry a 20% deduction, unregistered subcontractors 30%, and holders of gross payment status zero.3GOV.UK. What You Must Do as a CIS Contractor – Make Deductions and Pay Subcontractors Applying the wrong rate counts as a failure to deduct for the shortfall. A contractor who deducted 20% from a subcontractor who should have been on 30% is liable for the missing 10 percentage points.
The amounts add up quickly. A £50,000 payment to an unregistered subcontractor with no deduction produces a £15,000 recovery demand against the contractor. Interest runs on top from the date the tax should have been paid, and the usual statutory time limits apply for HMRC assessments, with extended limits available where careless or deliberate behaviour is shown.
Penalties That Stack On Top
Recovery of the tax is only the first layer. If the failure to deduct also meant the monthly CIS return was wrong or missing, further penalties apply.
Late returns trigger fixed penalties under Schedule 55 of the Finance Act 2009 whether or not any tax was actually due.4Legislation.gov.uk. Finance Act 2009 Schedule 55 – Penalty for Failure to Make Returns The day after the deadline brings £100. Two months late adds £200. Six months late brings the greater of £300 or 5% of the tax liability. Twelve months late adds another £300 or 5% floor, and if HMRC treats the withholding as deliberate the twelve-month penalty rises to 70% of the tax (minimum £1,500), or 100% (minimum £3,000) where it was deliberate and concealed. A return a year late therefore carries a floor of £900 in fixed penalties before any percentage calculations, and the percentages can dwarf the fixed amounts once the underlying tax is significant.
Filing on time but with wrong figures is a separate exposure under Schedule 24 of the Finance Act 2007. HMRC categorises the behaviour behind the inaccuracy. An honest mistake made despite reasonable care carries no penalty. Careless errors, deliberate understatement, and deliberate concealment attract progressively higher percentages of the potential lost revenue. Cooperating with HMRC reduces the figure: explaining how the error happened, helping quantify it, and giving access to records all count. Careless penalties can also be suspended for a set period on conditions designed to stop the same mistake recurring. Deliberate inaccuracies cannot be suspended.
Losing Gross Payment Status
For contractors who themselves hold gross payment status, a failure to deduct can quietly cause the greater damage. Gross payment status depends on continuous compliance, tested over a rolling twelve months, covering both filing CIS returns on time and paying deductions over by the due date.5GOV.UK. CIS305 Notes – Gross Payment Status Compliance Test
HMRC allows a small tolerance. Up to three late monthly returns are disregarded provided none was more than 28 days late. Up to three late payments of £100 or more are disregarded provided none was more than 14 days late. Late payments below £100 are disregarded entirely.5GOV.UK. CIS305 Notes – Gross Payment Status Compliance Test
Beyond those margins, status is revoked. The contractor’s own clients must then start deducting 20% from every payment made to them, which can strangle cash flow on projects operating with subcontractor chains and thin margins. Reinstatement requires passing the compliance test cleanly across a fresh twelve-month period.
Where the Subcontractor Stands
A failure by the contractor to deduct does not wipe out the subcontractor’s own tax. The subcontractor remains liable for income tax or corporation tax on the full earnings and must still declare the income on their own return. What changes is the paperwork. Without a payment and deduction statement, the subcontractor has no proof of any tax withheld and cannot offset it against their bill. If a contractor deducted tax but never paid it over, the subcontractor can still claim credit by giving HMRC copies of invoices and bank statements showing the net payment received, and HMRC will pursue the contractor. If no deduction was made at all, the subcontractor simply pays the full tax themselves.
Regulation 9 Relief: The Narrow Escape
Regulation 9 of the CIS Regulations 2005 allows a contractor to apply for a direction that removes the liability for the missed deduction. Two conditions must both be met.
Condition A requires the contractor to show they took reasonable care to comply and that the failure was either a good-faith error or a genuine belief that the payment fell outside the scheme.6HM Revenue & Customs. Construction Industry Scheme Reform Manual – CISR83050 – Direction Under Condition B at Regulation 9(4) Condition B requires that the subcontractor was either not chargeable to tax on those payments, or has already filed a return including the payments and paid the tax due.7GOV.UK. Construction Industry Scheme – A Guide for Contractors and Subcontractors CIS 340
Condition A is where most applications fail. HMRC will look at whether the contractor had verification systems in place, whether they followed them consistently, and whether the failure was a genuine oversight rather than a pattern. A contractor who never verified the subcontractor’s status has no realistic prospect of relief. If HMRC refuses the direction, the contractor has a right of appeal.
Fixing the Failure
The correction route depends on the scale of the problem. Isolated errors on monthly returns — a missing payment, a wrong deduction figure — should be amended through the HMRC CIS online service or commercial CIS software.7GOV.UK. Construction Industry Scheme – A Guide for Contractors and Subcontractors CIS 340 Returns too old to amend online are corrected in writing to HMRC.
Where the failure is more serious, such as operating outside the scheme entirely for a period, HMRC’s digital disclosure service is the right route.8GOV.UK. Make a Voluntary Disclosure to HMRC You register a disclosure, receive a reference number, and provide a full breakdown of payments, subcontractors, and the deductions that should have been made. HMRC then assesses the total liability including interest and penalties.
Timing changes the penalty. HMRC gives credit for unprompted disclosure when calculating reductions, so coming forward before HMRC makes contact typically produces a materially lower bill than waiting for an investigation to land.