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In part 2 of tax tips for trading in property, we will be covering why you might run your property through a limited company, property accounts and records, and the Construction Industry Scheme otherwise known as the CIS.
If you missed out of part 1 of Tax Tips for Trading in Property, you can catch up here.
Running A Property Business as a Limited Company
In some cases, it may be advantageous to use a limited company for your property development trade. This is because a company pays Corporation Tax at only 19% on its profits – so on a profit of £60,000 like Simone’s above, the corporation tax would be only £11,400. (Note, however, that the Chancellor announced in the 2021 Budget that the main rate of Corporation Tax will increase to 25% from 1 April 2023, although the first £50,000 of profits will usually still be taxed at only 19%, as now).
The situation is not as simple as this, however – if you want to extract the cash from the company for personal use, then there may be additional tax costs. The decision whether to use a company or not is not an easy one – see our guide “How to Use Companies to Reduce Property Taxes”, available from www.property-tax-portal.co.uk.
Keeping Accounts and Records When Trading in Property
It is essential to set up a good record-keeping system to keep track of your income and outgoings, and to keep those records safely – this is equally true of rental income, of course, but in the case of trading records, you are required to keep the records until the fifth anniversary of the 31 January after the end of the tax year – so for 2021/22, the records must be kept until at least 31 January 2028.
A trader’s accounts are generally prepared on the “accruals” basis – but unlike a property investor, you may make up your accounts to any date you choose.
For each tax year, you will be taxed on the profits of the accounting year ending during that tax year – if your accounts are made up to the year ending 30 September, for example, for the tax year 2021/22 you will pay tax on your profits for the year ending 30 September 2021.
In the first couple of years of trading, the method is slightly different:
- First year – you will be taxed on the profits from the date you began trading to the following 5 April – so if you started trading on 1 October 2020, you would be taxed on the profits from 1 October 2020 to 5 April 2021 for 2020/21. If you make your accounts up to a different date, the profits will be apportioned to arrive at the correct figure for the period to 5 April.
- Second year – Basically the profits of your first twelve months of trading.
The fine detail of how profits in the early years are taxed, and the choice of the most tax-efficient accounting date, can be very complicated, and you would be wise to seek advice from your accountant or tax adviser.
What is the Construction Industry Scheme (“CIS”)
If you engage in “property development”, you will be required to register for and operate this scheme.
It does not normally apply to property investors (such as Buy to Let landlords), and if you really only do minimal refurbishment on your “turnarounds” you MAY be able to justify not joining it, but if you do “refurbs”, or if you engage in property development, you will be a “property developer” for the purposes of the CIS, and you must register as a “contractor”.
What do these words mean?
A “property developer” could be an individual, a partnership, or a limited company. The key is, do they earn their profits by doing building work – either by new builds which they then sell, or by buying an existing property, and improving it, and then selling it on? If so, then they are a property developer.
A “contractor” is a person – including a company – whose business involves using other people’s labour to carry out building work. Almost all “property developers” use the services of independent bricklayers, carpenters, painters, electricians, plasterers, and so on, so almost all of them will be “contractors”.
“Buy to Let” investors will probably not be “property developers” or “contractors” because, although they may use the same tradesmen to do work on their properties, they make their income from renting them out, not from selling them – they are investors, not traders. If they spend more than £3million in any 12-month period on “construction operations”, however, then they will be in the scheme as a “deemed contractor”. Likewise, if they undertake a substantial development project – even for letting purposes – HMRC may argue that they are temporarily “caught” by the regime.
(A “deemed contractor” is basically a person whose main activity is not construction work, such as a landlord or retailer, but whose overall business activity involves sufficient construction operations to trip the £3million rolling 12-month threshold. The threshold worked a little differently, prior to April 2021. Unfortunately, HMRC does not even stick to this rule, particularly when it comes to landlords, and will often try to argue that the business includes “construction operations” during a major construction project, and has temporarily become a mainstream contractor, therefore bypassing the deemed contractor threshold.)
The “Construction Industry Scheme” imposes very onerous duties on “contractors” and “subcontractors”. In order to understand why the scheme is as it is, we need to look at its history…
Back in the 1960s, the construction industry in the UK was notorious for widespread tax evasion. Workers on building sites, who told the foreman their names were “Michael Mouse”, or “Roy Rogers”, got paid in cash, and had never seen a tax return in their lives. When the Tax Inspector attempted to trace them, to his or her surprise, there was no Mr Mouse at the given address – and often the address was false as well.
There were two basic problems:
- Some of the “Mickey Mice” were really employees of the building contractor, and should have had PAYE applied to their wages through payroll.
- The rest of them, though genuinely self-employed, did not declare their income and pay tax and NICs on it as they should have done.
Against this background, the “Construction Industry Scheme” (“CIS”) was first introduced in 1970. Since then, it has been much modified – with a major “reform” in 1999, and more major changes taking place in April 2007. The basic concept of the scheme remains the same, however.
The CIS is based on HMRC’s distrust of everyone involved in the construction industry. It assumes that if builders are allowed to conduct their tax affairs like any other business in the land, they will lie and cheat and not pay their tax.
Case Study – The Construction Industry Scheme
Jackie owns a plot of land with planning permission to build a house on it. She decides she will build a house and sell it. She knows she will occasionally need specialists to do some of the work.
At this point, Jackie has decided to trade as a property developer – a speculative builder, in fact – so she is now a “contractor” for CIS purposes. Jackie must immediately register with HMRC as a “contractor”. She is obliged to read through many pages of guidance on how to operate the scheme as an unpaid tax collector.
Jackie talks to Bob (the builder), and they agree a price for Bob and his workforce to build the house. It is agreed that Jackie will pay Bob £5,000 when his men start work.
Jackie must contact HMRC (online) to verify if Bob is registered as a subcontractor.
HMRC confirms Bob is registered for “Gross Payment”.
Jackie can pay Bob without deducting tax.
Jackie has also asked an electrician, Michael Faraday, to do the wiring on the new house. Before paying him, she contacts HMRC, who tell her that Michael is registered for “Net Payment”.
Jackie must deduct 20% tax from payments to Michael in relation to his construction services – generally, the invoice net of materials costs. If Michael had not been registered at all, the tax to deduct would have been 30%.
Once a month, Jackie must send the tax she has deducted to HMRC, together with a return of payments made, signed to certify that she has operated the scheme correctly. This must be done within 14 days of the end of the month (but Jackie must remember that a CIS month ends on the 5th day of the following month, so in fact she has until 19 July to send in her deductions for June). This regime must still be followed even when no CIS payments are made that month, although it is possible to make a Scheme temporarily ‘dormant’.
That was a VERY abbreviated version of how the scheme works – the reality is more complicated and difficult to comply with.
Why Bother with the CIS?
The short answer is that there are penalties if you don’t!
If Jackie failed to register as a contractor, or failed to deduct tax from payments to Michael, she could be liable for:
- Penalties of up to £900 for each late monthly return she makes (it could be more in cases where the CIS tax is high enough – and potentially an extra £3,000 or more per return, if the return is more than 12 months late, depending on whether or not HMRC decides the failure to file on time was deliberate)
- Unless Jackie can satisfy HMRC that Michael has paid his tax himself, Jackie can be liable for the 20% tax that Jackie should have deducted from the payments she made to Michael
If you are trading as a property developer, building (or buying and improving) properties for sale, you are automatically a “Mainstream Contractor” and liable to operate the CIS. There is no lower limit below which you do not have to operate this scheme.
One of the many unjust features of the CIS regime is that there are probably a lot of small-scale property developers out there who do not know they should be operating the scheme.
Those who do comply with the scheme are at a disadvantage, because many small “domestic” building firms simply will not work for a CIS “contractor” due to the bureaucratic and cashflow implications; builders who work only on people’s own homes, with the homeowner as the direct client, are not required to be in the CIS.
To find out more about the CIS, visit HMRC’s website and look for “CIS” – or speak to your Tax Adviser.
