HMRC is writing to Construction Industry Scheme (CIS) contractors where it believes the wrong deduction rate may have been applied to subcontractor payments made between 6 April 2025 and 5 April 2026.

Receiving a letter does not necessarily mean an error has been made, but it should not be ignored. The campaign is also a useful prompt for all contractors to check whether their CIS processes are working as intended.

In this article we outline some practical tips and checks contractors can undertake to perform an initial risk assessment.

Broadly, CIS is HMRC’s regime for how contractors should treat payments to subcontractors carrying out construction work. CIS is considered once a contractor has already determined that the individual(s) is not an employee for tax purposes.

Contractors need to:

1. consider whether the work and payment fall within CIS;
2. verify subcontractors with HMRC where required;
3. apply the payment status determined by HMRC. Depending on that status, the subcontractor may be paid gross or CIS deducted at 20% or 30%;
4. submit monthly CIS returns and pay deductions over to HMRC; and
5. provide payment and deduction statements to subcontractors where CIS has been deducted.

A reminder on materials:

• Where a contractor is required to deduct CIS at 20% or 30%, the CIS tax deduction I not necessarily on the full amount invoiced. The contractor  needs to identify what amounts can be excluded, such as direct costs of qualifying materials incurred by the subcontractor.
• The materials excluded must represent the direct cost incurred by the subcontractor in carrying out the construction operations under the particular contract. The contractor also needs to be satisfied that the direct material cost is reasonable.
• In practice, this means considering whether the labour/material split looks reasonable and whether the materials figure represents the subcontractor’s actual direct cost, rather than a selling price containing profit, mark-up or other costs that do not represent the qualifying direct cost.

1. Have changes in CIS subcontractor status been actioned?
   
   Verification is unfortunately not a one-off event when the subcontractor is first engaged.Where HMRC notifies you of a change in a subcontractor’s payment status, check that the change has been updated in your payment system and that the correct deduction rate has been applied as soon as practically possible.

   If there are any gaps in service of 2 years or more, then it is also necessary to re-verify the subcontractor’s status.

2. Are plant costs genuinely deductible?
   
   Where a subcontractor hires plant from a third party to carry out construction work, the cost of the plant hire, together with relevant consumables such as fuel, may be treated as materials when calculating the CIS deduction.However, if the subcontractor already owns the plant, they cannot create a notional plant-hire cost and deduct this as materials. Plant acquired under a hire-purchase agreement does not qualify as plant hire either.

   Practical check: where plant hire has been excluded from the amount subject to CIS, can you evidence that the subcontractor hired it from a third party?

3. Does the labour/material split stack up?
   
   Attention should be given to subcontractors subject to deductions at 20% or 30%.Unfortunately accepting an invoice showing separate labour and materials figures may not be enough to satisfy HMRC you have undertaken reasonable care/steps.

   HMRC’s guidance focuses on the direct cost of materials to the subcontractor and requires the contractor to be satisfied that the amount is reasonable.A good control framework should therefore create an audit trail.  Best practice looks like:

If the materials figure changes significantly along the way, is somebody asking why?

And does someone sense-check whether the final materials value looks reasonable given the work undertaken?

4. Have you tested what sits behind the materials figure?
   
   It is worth sample checking material deductions rather than relying on how an invoice has been presented. For selected payments, ask:

• • • Did the subcontractor incur the material cost?
    • Does it relate to the construction contract concerned?
    • Can the amount be traced to supporting evidence?
    • Is the amount reasonable?
    • Does the amount excluded from CIS represent the subcontractor’s direct cost, rather than a selling price that includes profit or mark-up?
    • Are other costs bundled into “materials” that need to be considered separately?

HMRC describes direct cost as what the subcontractor can demonstrate it directly paid for the materials, with the materials needing to relate to the construction contract concerned.

The key question isn’t “Does the invoice show materials?”  It is “Can we evidence why this amount was excluded before calculating CIS?”

If you’ve received a letter from HMRC, don’t panic, but review the position before responding. HMRC’s current process allows recipients to report an underpayment or other errors, or explain why they believe their returns are correct.  Remember this isn’t an enquiry, its HMRC asking for more information and a considered approach should always be undertaken alongside appropriate professional advice.

Even if you haven’t received a letter, this is a good opportunity to test your controls. A targeted review could focus on:

• changes to subcontractor CIS status;
• subcontractors subject to 20% or 30% deductions;
• significant or unusual materials deductions;
• plant costs; and
• unusual labour/material splits.

If you have received a CIS letter, identified a possible issue or simply want assurance that your processes are working correctly, our Employment Taxes team can review your verification records, deduction rates and materials treatment, quantify any potential exposure and support you with your response to HMRC, please get in touch.