Whether CIS or PAYE is better for construction industry contractors depends on several factors, including the amount of tax they are likely to save or pay and how simple they want to keep their tax affairs in general.
In the UK, subcontractors can either pay tax at a fixed rate or have their tax calculated based on their profits.
A fixed tax rate is simple and easy to administer, particularly if you are a sole trader. You know exactly how much tax will be taken off and you don’t have to worry about keeping track of expenses. However, it can be more expensive than paying tax based on profits, especially if you have a low-profit margin for the tax year.
Tax calculated based on profits is more complex but can save you money in the long run. You only pay tax on your profits and deduct expenses from the income earned. This can lead to a significant tax saving if you have relatively high expenses. One of the key differences is that you need to keep detailed records of all expenses to claim the maximum tax deduction.
Whether you choose the Construction Industry Scheme or PAYE as a subcontractor will depend on individual circumstances. If you want simplicity and peace of mind, a fixed tax rate approach is the best option. If you want to save money, having tax calculated based on profits may be the better choice.
Here we look at the difference between CIS tax and NICs compared to a self-employed worker and what factors affect the choice of one over the other.
What is the difference between Construction Industry Scheme (CIS) and PAYE?
The Construction Industry Scheme (CIS) was created to reduce tax evasion in the industry when companies hire subcontractors. CIS applies to all construction work in the UK, regardless of the size of the project.
You can find more details on the main government website here.
To be part of CIS, contractors and subcontractors must both be registered with HM Revenue and Customs (HMRC) and meet certain criteria. CIS rules mean a contractor is required to deduct 20% from payments made to subcontractors and pay this to HMRC.
This 20% covers both income tax and NIC. This is different from gross payment status, where the contractor pays you the full amount without any deductions and you pay your tax and NICs through an assessment at the end of the year.
Under PAYE, employers are required to deduct tax from construction workers wages and pay this to HMRC on a weekly or monthly basis. The amount of tax deducted depends on the employee’s income and tax code.
Construction workers who are employees are not required to do anything to participate in PAYE. They will usually receive a payslip outlining their gross income along with any deductions and net pay.
Advantages of being a subcontractor
- You can set your own rates.
- You can choose your own projects.
- There is generally greater flexibility in terms of when and where you work.
- You can claim expenses and reduce your tax burden.
Disadvantages of being a subcontractor
- You are responsible for your own tax and NI contributions as well as bookkeeping.
- You may not have access to the same benefits as employees, such as holiday pay and sick pay.
- You could find it more difficult to get work with more competition from other subcontractors.
Advantages of being an employee
- You are paid a regular wage.
- Your employer takes care of your tax and NICs, you are also entitled to things like holiday and sickness benefits.
Disadvantages of being an employee
- You won’t have as much flexibility in terms of when and where you work and you can’t generally set your own rates.
- You may not have as much control over your work as a subcontractor.
Who pays more tax?
A lot depends on how much you earn and what type of construction work you undertake. Someone who is a subcontractor under CIS pays a flat rate of 20%. If you are on PAYE your rate is determined by your tax code and income.
If you have a low turnover, PAYE will generally turn out more tax efficient. If you have a high turnover, then CIS can often deliver more savings as you can claim expenses.
Who pays your NI contributions when you’re a contractor?
Contractors are responsible for paying their own National Insurance contributions and the amount paid will depend on income earned if they are classed as self-employed when they complete their tax return.
That means will need to register with HMRC and complete a self-assessment each year. If you are classed as employed, your NICs are covered by the PAYE scheme and will be calculated by your employer on a monthly basis and paid to HMRC.
How is NI paid on CIS?
You will need to register with the HMRC for self-assessment and complete a tax return by the end of January each year. Your National Insurance will be calculated alongside your tax payment for the financial year.
For Class 2 NIC, you need to pay £3.10 per week on earnings over £6,725 a year. For Class 4 NIC, you should pay 9% on profits between £9,568 and £50,270 per year, and 2% on profits above £50,270 per year.
What is the National Insurance rate for PAYE?
Employees pay Class 1 NIC. You don’t pay anything on the first £1,048 that you earn in a month. On income between £1,048 and £4,189 you pay 12%. Anything above this for the month, you will pay 2%.
Working through an umbrella company
Some sole traders work through an umbrella company which works as a separate entity from the construction company. In this case, the construction worker is seen as an employee of the umbrella company who pays their wages and handles all tax and NICs.
Pay tax on time with VW Taxation
Handling your invoices and other paperwork for the tax year can be challenging for busy subcontractors in the construction industry.
Working with a qualified accountant will help you keep track of payments, and invoices and ensure that you reduce the amount of overpaid tax that you pay.
VW Taxation is a specialist accounting service for the construction industry based in Portsmouth.