A Retrospective look at the changes to the Construction Industry Scheme

Back in April 2024, following a consultation process, the Government introduced regulations to change the scope of application of the Construction Industry Scheme (“CIS”). One of the stated aims of the regulations was to “remove the majority of landlord to tenant payments from the scheme”. As we are well into the second year of  implementation of the regulations, now would seem as good a time as any to reflect on the changes made to the CIS and whether in practice they have achieved their intended aims.

Before we turn to the finer details of the changes caused by the regulations, and the effect they have had on landlords and tenants in practice, let’s first take it back to basics.

What is the CIS?

The CIS governs payments made by contractors to subcontractors for construction operations in the UK. Construction operations cover the majority of works undertaken to a building, structure or civil engineering installation.

Depending on the relevant subcontractor’s tax status, a contractor registered under the CIS may be required to make tax deductions from payments made to subcontractors for construction work, with the amount withheld then being paid to HMRC by the contractor. The CIS only applies to labour costs; no deduction is required in relation to payments for building materials.

How did the CIS apply to lettings prior to the regulations?

A landlord could be deemed to be a contractor where they made a payment to a tenant for construction operations to be carried out by that tenant.

This would typically arise where a landlord is due to carry out works to premises to make them ready for fit out by an incoming tenant, or even to make them ready for the tenant to use straight away, and would employ the tenant as its subcontractor to carry out the “landlord’s works”. Prior to the introduction of the regulations, the payments made by the landlord to the tenant for those works would fall within the remit of the CIS and could be subject to tax deductions unless the tenant registered itself as a sub-contractor with “gross payment status” under the CIS.

This did not, however, apply to contributions made by a landlord towards a tenant’s fit out works where those contributions were designed to incentivise a tenant to take a lease. Such genuine letting incentives are excluded from the CIS.

What changes were made by the regulations?

The regulations sought to bring payments made by landlords to tenants for “landlord’s works” outside of the scope of the CIS, provided that the following conditions are met:

• The payment is made by or on behalf of the landlord
• The person receiving the payment is a tenant or prospective tenant of the landlord
• The payment is for construction operations agreed in connection with a lease or an agreement for lease
• The tenant must carry out the construction operations itself, or contract a third party to do so pursuant to a contract with the tenant
• The construction operations are intended to be primarily for the benefit and use of the tenant.

How are the regulations affecting us now?

It appears that, on the whole, the effect that it had been hoped the regulations would achieve is gradually becoming a reality, with fewer new lettings being caught by the CIS.

However, this does not mean that landlords and tenants can now ignore the CIS, and we would still stress the importance of exercising caution when it comes to considering its application to any new lettings. Nuances in the nature of the works being carried out could still see some payments to tenants for “landlord’s works” being caught by the CIS in spite of the regulations.

For example, whilst works carried out by an incoming tenant to strip out an outgoing tenant’s fit out works should fall outside the scope of the CIS if the other criteria detailed above are met, it is not always so clear cut. In particular, it is not always obvious whether works that might fall outside of premises being demised to a tenant are “primarily” for its benefit or not, especially in light of guidance published by HMRC which indicates that what is considered to meet the “primary benefit” test is far narrower than what had been envisaged. For further details, HMRC’s guidance can be accessed here. In addition, the parties need to be satisfied that the tenant is either carrying out the work itself or there is a contract in place with a third person to do the work.

It is, therefore, essential that specialist advice is taken where there is any uncertainty as to whether works fall within the scope of the CIS in order to avoid any landlords or tenants being caught out.

Notwithstanding this, the changes to the CIS are still welcome and are alleviating the administrative burden of dealing with tax deductions for some landlords and tenants. However, as is often the case, best practice would be for landlords and tenants to still err on the side of caution when it comes to the CIS. If you have any questions about this topic, our Real Estate team can help.