UK Construction Industry: CIS and Domestic Reverse Charge (DRC)

A comprehensive guide to the two key tax mechanisms governing payments in the UK construction sector.

1. The Construction Industry Scheme (CIS)

The CIS is a system where the contractor deducts a portion of a subcontractor's payment and passes it directly to HM Revenue & Customs (HMRC). These deductions count as advance payments towards the subcontractor's final tax and National Insurance liabilities.

Key Features & Deduction Rates

Feature Contractor's Role Subcontractor's Role
Purpose To reduce tax evasion by deducting tax at source. To have tax deducted in advance, counting towards their tax bill.
Registration Must register if you pay subcontractors for construction work. Don't have to register, but will suffer a higher deduction rate if unregistered.
Deduction Rates Must verify the subcontractor's status with HMRC:
  • 0% (Gross Payment Status) if registered and meets certain criteria.
  • 20% if registered with HMRC.
  • 30% if unregistered with HMRC.

CIS Example (Pre-Deduction)

A Subcontractor (registered for CIS at 20%) submits an invoice to a Contractor:

Item Value Notes
Labour £1,000 The amount the CIS deduction is applied to.
Materials £200 CIS is not deducted on materials.
Net Due (Subtotal) £1,200 Net amount before CIS deduction.
CIS Deduction (20% of £1,000 Labour) (£200) Amount the contractor withholds and pays to HMRC.
Total Paid to Subcontractor £1,000 The amount the subcontractor actually receives.

2. Domestic Reverse Charge (DRC) for VAT

The DRC changes who accounts for the VAT. It shifts the liability for accounting for output VAT from the supplier (subcontractor) to the customer (contractor). This is a measure to combat "missing trader" VAT fraud.

DRC Decision Criteria and Process

Feature Standard VAT Rule Domestic Reverse Charge (DRC)
Supplier (Subcontractor) Charges and collects VAT from the customer. Does not charge or collect VAT from the customer.
Customer (Contractor) Pays the VAT to the supplier and reclaims it from HMRC (Input VAT). Accounts for both the Output VAT (Box 1) and the Input VAT (Box 4). The entries net to zero VAT due/reclaimed for the customer.
DRC Applies If:
  • 1. Both the supplier and customer are VAT registered in the UK.
  • 2. The services are subject to CIS.
  • 3. The services are standard (20%) or reduced-rate (5%) VAT.
  • 4. The customer is not an 'end user' or 'intermediary supplier'.

DRC Example (Combined with CIS)

Subcontractor (VAT/CIS Registered) invoices Contractor (VAT/CIS Registered) for DRC-applicable work:

Item Subcontractor's Invoice Contractor's VAT Return Entries
Net Value (Labour + Materials) £1,200 Box 7 (Purchases excl. VAT): £1,200
VAT (20%) £0 (Must state: "Reverse Charge: Customer to pay VAT to HMRC") Box 1 (Output VAT): £240, and Box 4 (Input VAT): £240
CIS Deduction (20% of Labour) (£200)
Total Paid to Subcontractor £1,000 Net Effect: The £240 VAT entries cancel each other out.

End-User Exemption Example

If the Subcontractor works for a Property Owner (End-User), the DRC does not apply, but CIS still does:

Item Subcontractor's Invoice to End-User
Net Value (Labour + Materials) £1,200
VAT (20% Standard VAT Rules Apply) +£240
Gross Due £1,440
CIS Deduction (20% of Labour) (£200)
Total Paid to Subcontractor £1,240

Interactive CIS & DRC Decision Tool

Click through the questions to determine the correct invoicing and payment process.

Detailed DRC & CIS Decision Flow

Click on each step to reveal the decision details.

Step 1 Is the work subject to CIS? ▼

CIS covers most building, construction, alteration, repair, decorating, or demolition work.

  • YES: Proceed to Step 2.
  • NO: Stop. CIS and DRC do NOT apply. Use normal invoicing and VAT rules.

The Contractor must verify the Subcontractor's status with HMRC to determine the deduction applied to the labour component of the invoice.

  • 0%: Gross Payment Status (Registered and meets HMRC tests).
  • 20%: Registered with HMRC.
  • 30%: Unregistered with HMRC.

DRC does NOT apply if:

  1. The customer (Contractor) is an "End User" (not selling on construction services, e.g., a property owner).
  2. The customer (Contractor) is NOT VAT registered (even if subject to CIS).
  3. The supply is exempt or zero-rated VAT.

IF DRC does NOT apply: The Subcontractor issues a normal VAT Invoice (+20% or 5%). Contractor pays Subcontractor Gross VAT minus CIS Deduction.

This applies when DRC is NOT excluded (i.e., both parties are VAT registered and the customer is not an End User).

  • Subcontractor Invoicing: Must state "Reverse Charge: Customer to pay VAT to HMRC". The VAT amount on the invoice must be £0.
  • Payment to Subcontractor: Contractor pays Subcontractor Net value minus CIS Deduction.
  • Contractor VAT Return: Contractor accounts for the VAT (Box 1 Output VAT and Box 4 Input VAT). The VAT liability is neutralised.
Final Step: Contractor MUST pay the CIS deduction to HMRC.

Combined CIS & DRC Decision Flow (Quick Reference)

Follow this structured flow to determine the correct invoicing and payment process:

  1. Step 1: Is the work subject to CIS?
    If the work is not construction (e.g., scaffolding hire only, professional services), then CIS & DRC do NOT apply. Use normal invoicing and VAT rules.
  2. Step 2: Determine CIS Deduction Rate.
    The Contractor must verify the Subcontractor's status with HMRC:
    • Result A:0% (Gross Payment Status)
    • Result B:20% (Registered)
    • Result C:30% (Unregistered)
  3. Step 3: Check DRC Applicability (End User/VAT Status).
    Ask: Is the Contractor an "End User" (e.g., a homeowner or final client not re-supplying construction services)? OR is either party NOT VAT registered?

    IF YES to any of the above: DRC does NOT apply.

    The Subcontractor issues a normal VAT Invoice (+20% or 5%) and the Contractor pays the Subcontractor Net + VAT - CIS.

  4. Step 4: Execute DRC.

    IF NO (i.e., Contractor is NOT an end user, AND both parties are VAT registered): DRC DOES apply.

    • The Subcontractor's invoice must clearly state: "Reverse Charge: Customer to pay VAT to HMRC."
    • The Subcontractor is paid Net - CIS Deduction (0%, 20%, or 30%).
    • The Contractor records the VAT (Box 1 and Box 4) on their VAT return (Net effect: £0).
  5. Final Step: Contractor's HMRC Obligation
    The Contractor MUST pay the CIS deduction amount (from Step 2) to HMRC.