CIS v PAYE – is it better to employ or subcontract?

by | Feb 12, 2022

According to the FMB, almost 20% of small and medium businesses in the UK are construction companies. Despite this, it’s not an easy industry to navigate.

Building regulations, H&S legislation and tax laws are constantly evolving. On top of that, construction is the only industry in the UK where the self-employed are taxed at the source. And it doesn’t help that there are loads of myths and misconceptions about how long you can work with subbies before HMRC starts investigating their employment status.

With all this going on, it’s not surprising that running a construction business can be a real headache.

We can’t help with building regs or H&S, but we can help you unravel the rules around CIS and the way you work with subbies.

What is the Construction Industry Scheme (CIS)?

The Construction Industry Scheme was brought in by HMRC in 1971 to reduce tax evasion in the construction industry.

You can register for CIS as a sole trader, partnership or limited company, and both contractors and subcontractors must be registered before starting any work.

As a CIS subcontractor, you are considered self-employed, but when you complete work for a contractor, they make CIS deductions at a rate of 20%. This is then held by HMRC to be used against your tax and national insurance contributions once these have been calculated.

Alternatively, you can apply for gross payment status, which means contractors will pay you in full. However, you will only qualify for gross payment status if you meet certain requirements.

As a self-employed person, you are responsible for your own tax affairs and will need to complete a self-assessment tax return each year. If you have your own limited company, you will also need to complete a company tax return.

What is PAYE?

Pay As You Earn (PAYE) is the system by which most employees in the UK pay income tax and national insurance (NI).

Payments are calculated by the company’s payroll team and deducted from your salary before you get paid. The amount you pay is based on your employee earnings and your tax code.

Your employer will pay your tax and NI contributions to HMRC directly, and you will usually receive a payslip outlining your gross income, any deductions and your net pay.

You will not need to complete a self-assessment tax return if your income comes solely from employment.

Does CIS come under PAYE?

The construction industry scheme (CIS) is a scheme for self-employed subcontractors, while PAYE is used for paying employees. Usually, you will pay tax and national insurance under one or the other, but there may be occasions where you pay tax under both. For example, if you are employed part-time by one construction business under PAYE but are taking on freelance construction work for other companies as a self-employed contractor, both apply.

Your employer will take care of tax and NI for the money you earn as an employee, but you’ll need to be registered under CIS when you’re operating as a self-employed worker. The hiring contractor will be responsible for withholding tax from your earnings and making payments to HMRC.

You’ll need to complete a self-assessment tax return showing how much you have earnt from employment and how much you have earnt from self-employment, plus any tax you have already paid.

If you are switching from PAYE to CIS or vice versa within a single tax year, you might find it useful to get an accountant to help with the tax calculations and reclaim any overpaid tax.

If you are registered as a limited company rather than a sole trader, you might also have both CIS and PAYE liabilities.

Is it better to be a subcontractor or an employee?

Being employed has many advantages. You get paid a set wage, and all tax and NI contributions are calculated and paid for you under the PAYE scheme. You are protected under UK employment law, which entitles you to sick pay, holiday pay and redundancy pay (depending on length of service). Your employer will also make pension contributions for you (if you meet the criteria).

You don’t have the stresses or responsibilities of self-employment, such as finding work, managing cash flow, sending or paying invoices, managing tax liability, and ensuring insurance, licences, and accreditations are up to date. You can essentially turn up to work each day, do your job and get paid.

However, self-employment isn’t all bad. It does give you more control and flexibility.

You can work for multiple contractors, choosing which projects you accept and decline. You can dictate your own rates and working hours (within reason) and grow your business the way you want, either as a limited company or sole trader.

You won’t get benefits such as holiday and sick pay, and you’ll have to manage your own pension, but you can often command a higher hourly rate than an employee because you have to cover these things yourself.

You’ll also be allowed to claim several expenses back at the end of the financial year when you complete your self-assessment tax returns.

Most subcontractors paid through CIS receive a tax refund at the end of the year. This is because CIS deductions are set at 20%, which isn’t based on a tax code. The amount you receive depends on the work you have done, the expenses you are claiming and the amount you have overpaid. There is also a difference in the way sole traders and limited companies pay tax, and it’s worth taking time to understand this difference before deciding how you want to operate.

As you can see, there are advantages to both employment and self-employment. The right option for you will come down to your individual circumstances and the opportunities available.

For contractors: should you employ or subcontract?

As a contractor, it is important to understand the difference between employing and subcontracting, as tax isn’t treated in the same way.

At first glance, employing workers might seem like the less appealing choice. Not only do you have to find enough work every month to cover their salary, but you also have to pay them when they’re off sick or on holiday.

Then you have the hassle of managing the payroll (or paying someone to do it for you). You have to calculate and cover tax, NI and pension contributions, make sure payments are all made to the right places and send out the payslips.

Plus, you’re responsible for training and development, renewing any licences and accreditations, and providing tools, materials and equipment.

Sounds like a lot of extra stress, right?

What are the advantages of employing staff?

Before you dismiss the idea of employing a team, there are some advantages to putting your best subbies on PAYE.

Yes, you will have to ensure your pipeline stays full to avoid paying people to sit around on their arses all day, but it’s not all bad.

Subcontractors are not required to accept work when you offer it. So, if they’re presented with a better deal or a more exciting project elsewhere, you might find yourself short-handed last minute.

On the other hand, if you have permanent employees, you know you have the workforce needed to deliver on your promises. Better for your customers and better for your reputation.

You have more control over their working schedule, can set the standards for their work and have peace of mind that insurance, licensing and training are all adequate and up to date.

As for the administration aspect, it’s actually not that complicated. Outsourcing your payroll can be relatively inexpensive, and you’ll know exactly what your payroll costs will be each month.

And the best part of employing reliable people? You never have to worry about HMRC questioning the employment status of your subbies and reclassifying them as employees.

What is the downside to subcontracting?

Subcontracting gives you a little more flexibility – you can scale your team up and down to meet project demands, and you aren’t liable for holiday, pension contributions or sick pay. However, there are some downsides to subcontracting.

Firstly, your subcontractors aren’t tied to you – they aren’t obliged to take on the work you offer them. If they already have alternative obligations or are offered alternative work at a better rate, they can take that work over yours, and you’ll have to find different subbies or wait until they can accommodate you. They can also determine their working hours which might not match up with what you want.

Secondly, you don’t have as much control over how they work. They might have their own systems, or they might not have been trained the way you would have trained them. They might not behave in the way you’d expect representatives of your company to behave, and the quality of their work might not meet your standards.    

Thirdly, the rates you pay subbies will usually be higher than the hourly rate you’d pay an employee. This is because subcontractors have to cover costs that an employee will usually have covered by their employer. Things like sickness or holiday pay, pensions, licences, insurance, tools and so on.  

You’ll also need to keep track of CIS rules, as you’ll be responsible for ensuring the tax deducted is correct for each CIS subcontractor. Certain expenses are subject to CIS tax, and keeping track of changes to the CIS scheme can be an extra headache. You can use an umbrella company to manage CIS payments, but this comes with its own disadvantages.

So although subcontracting might give you more flexibility, it can also mean less control over your workforce and more cost long-term.

Who determines employment status?

It is the main contractor’s responsibility to determine the employment status of their construction workers. A subcontractor cannot simply be self-employed just because they like the idea of it. Equally, you cannot keep a subcontractor self-employed if they are actually an employee.

If HMRC opens an enquiry into the employment status of your subcontractors and deems them to be employees, you will be liable for paying any backdated tax and NI, as well as any fines or penalties.

So if you do need long-term labourers, it’s worth considering the PAYE route.

That said, if there are legitimate business reasons for why you work with your subbies the way you do, there’s no reason you can’t work with them under the CIS scheme for as long as you want.

And that’s where HardHats comes in.

How can HardHats help?

It doesn’t matter how many subcontractors you’ve got or how long you use them. It’s how you work with your subcontractors that determines whether they should be employees or self-employed contractors.

After all, if a payroll company can pay subcontractors long-term and keep HMRC happy, so can you.

We put together a bespoke, watertight, insurance-backed contract that outlines the working relationship you have with your subbies. This means that if HMRC ever does come looking in your direction, they won’t misinterpret the employment status of your subbies.

And if they do make an enquiry, we handle it on your behalf – we’ll even pay any costs and fines if they do reclassify your subbies as employees.

You can find out how it works here, or better still, book a call and let us show you how you can work with subbies long-term and keep HMRC happy.

You might not even need our help!

But if you use labour-only subcontractors long-term and want to continue doing so, let’s have a chat. If you are at risk, we’ll take that risk off your hands.

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