The Construction Industry Scheme (CIS) is a tax deduction system implemented by HM Revenue & Customs (HMRC) to regulate tax payments within the construction sector. Under CIS, contractors are required to deduct tax at source from payments made to subcontractors and pass it directly to HMRC. This system helps ensure that subcontractors pay the correct amount of tax and National Insurance contributions.

One of the most common questions that contractors and subcontractors ask is:
How do CIS tax deductions apply to labour costs?

This guide will cover:
✅ What labour costs qualify for CIS deductions?
✅ How CIS tax is calculated and deducted?
✅ How to stay compliant with CIS regulations?

By the end of this article, you’ll have a clear understanding of CIS tax deductions for labour costs and the best practices for compliance to avoid penalties from HMRC.

Understanding the CIS Tax Deduction System

Who Needs to Register for CIS?

The Construction Industry Scheme (CIS) applies to businesses and self-employed individuals who work within the UK construction sector. CIS registration is mandatory for:

  • Contractors: Businesses or individuals who hire subcontractors for construction work.
  • Subcontractors: Those who provide labour or services to contractors.

If you’re a contractor, you must:

  • Register for CIS with HMRC.
  • Deduct CIS tax from subcontractors’ payments.
  • Submit monthly CIS returns.

If you’re a subcontractor, you should:

  • Register with HMRC to avoid higher tax deductions.
  • Keep records of all deductions to reclaim any overpaid tax.

How CIS Tax Deductions Work

CIS requires contractors to deduct tax at source before paying subcontractors. The deduction is calculated as a percentage of the labour cost only (materials and other expenses are excluded).

🔹 Standard CIS Tax Deduction Rates:

  • 20% for registered subcontractors
  • 30% for unregistered subcontractors
  • 0% (gross payment status) for subcontractors approved by HMRC

Subcontractors who qualify for gross payment status receive full payments with no deductions, but they must meet strict tax compliance criteria.

What Labour Costs Can Be Deducted Under CIS?

✅ Labour Costs That Qualify for CIS Deductions

Contractors must apply CIS tax deductions only to labour costs. This includes:
✔️ Wages of subcontractors (self-employed workers)
✔️ Labour-only subcontractor payments
✔️ Self-employed workers providing a service (without materials)

❌ Costs That Cannot Be Deducted

Contractors should NOT deduct CIS tax from the following:
🚫 Materials: Any materials used in the construction work.
🚫 Equipment hire: If a subcontractor provides equipment or tools, these are excluded.
🚫 VAT: If the subcontractor is VAT-registered, the VAT amount is not subject to CIS deductions.
🚫 Travel & Expenses: Accommodation, travel, and subsistence costs are not part of the deduction.

How to Calculate CIS Tax Deductions on Labour Costs

Step-by-Step Guide to Deducting CIS Tax

1️⃣ Identify the labour cost from the invoice

  • If the invoice includes both labour and materials, separate the costs.

2️⃣ Apply the correct CIS tax rate

  • 20% for registered subcontractors
  • 30% for unregistered subcontractors

3️⃣ Deduct CIS tax only from labour costs

  • Materials and other expenses should NOT be included in the deduction.

4️⃣ Submit CIS deductions to HMRC

  • Contractors must report deductions via the monthly CIS return.

Example Calculation

A contractor receives an invoice from a subcontractor:

Description Amount (£)
Labour £2,000
Materials £500
Total Invoice £2,500

If the subcontractor is registered under CIS (20%):

  • Labour cost: £2,000 × 20% = £400
  • Amount paid to subcontractor: £2,100 (£2,500 – £400 deduction)
  • The £400 deduction is submitted to HMRC.

If the subcontractor is unregistered (30%):

  • Labour cost: £2,000 × 30% = £600
  • Amount paid to subcontractor: £1,900 (£2,500 – £600 deduction)

Compliance & Reporting Requirements

📌 Registering for CIS

📌 Filing CIS Returns

📌 Record-Keeping Requirements

  • Maintain records of all CIS payments and deductions.
  • Provide subcontractors with CIS deduction statements each month.
  • Keep records for at least 3 years for HMRC audits.

🚨 Avoiding Penalties

❌ Failing to deduct CIS tax correctly can lead to penalties.
❌ Late or incorrect CIS returns may result in HMRC fines.

Common CIS Tax Deduction Mistakes & How to Avoid Them

❌ Deducting CIS tax from non-labour costs – Always separate materials and expenses.
❌ Applying the wrong deduction rate – Verify subcontractor CIS status before paying.
❌ Not submitting CIS returns on time – Monthly returns are due by the 19th of each month.
❌ Failing to provide CIS deduction statements – Subcontractors need these to reclaim tax.

How LT Accounting Can Help with CIS Tax Compliance

At LT Accounting, we offer professional support for contractors and subcontractors to stay CIS-compliant and avoid costly mistakes. Our services include:

✅ CIS bookkeeping & payroll management – Ensuring correct tax deductions.
✅ CIS returns filing – Submitting accurate monthly returns to HMRC.
✅ Subcontractor verification – Checking CIS registration to apply the right tax rate.
✅ Reclaiming overpaid CIS tax – Helping subcontractors claim refunds from HMRC.

Need CIS tax support? Contact LT Accounting today!

Conclusion

Understanding CIS tax deductions for labour costs is essential for contractors and subcontractors to stay compliant and avoid HMRC penalties.

✔️ Only deduct CIS tax on labour costs (not materials or expenses).
✔️ Apply the correct tax rate (20%, 30%, or gross payment status).
✔️ Submit accurate CIS returns and provide subcontractors with deduction statements.

For expert CIS tax support and compliance guidance, LT Accounting is here to help!

📞 Contact us today to ensure your CIS tax deductions are accurate and compliant.