CIS changes: golden opportunity missed

From 6 April 2024, various changes to the construction industry scheme (CIS) became effective. These changes broadly relate to strengthening the requirements for gross payment status and excluding many landlord to tenant payments from the scope of the CIS.

The changes to the CIS were implemented through a combination of:

• section 35 of FA 2024 (which received royal assent on 22 February 2024), which amended s 66 and Sch 11 of FA 2004; and
• the Income Tax (Construction Industry Scheme) (Amendment) Regulations SI 2024/308 (which were made on 5 March 2024) (the CIS Amendment Regulations 2024), which amended the Income Tax (Construction Industry Scheme) Regulations SI 2005/2045 (the CIS Regulations 2005).

Gross payment status

Since 6 April 2024, gross payment status for the purposes of the CIS may be cancelled on the grounds of fraud in relation to PAYE, corporation tax or income tax self-assessment returns, or VAT (in addition to fraud in relation to the CIS). Compliance with VAT obligations has also been included in the compliance tests for gross payment status.

However, minor VAT compliance failures will not result in gross payment status refusal or removal, and any pre-6 April 2024 failure to comply with an obligation to account for or pay VAT must be disregarded for the purposes of a determination of cancellation of pre-6 April 2024 registration for gross payment status.

Landlord to tenant payments

Significantly for those operating in the property sector, the CIS Regulations 2005 have been amended to include new reg 20A, which excludes many landlord to tenant payments from the scope of the CIS, provided certain conditions are met.

The operation of the CIS in respect of such payments has been a bone of contention between landlords and tenants, so this change was hotly anticipated. However, many businesses and their advisers are questioning whether the new reg 20A goes far enough or whether this change is, in fact, not all that much of a change.

Regulation 20A provides that a payment under a construction contract is not a contract payment, and therefore, the CIS does not apply to that payment, if:

• 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 enforceable agreement to enter into a lease;
• the tenant that occupies or will occupy the property will carry out the construction operations itself, or a third person will carry out the construction operations pursuant to a contract with the tenant; and
• the payment is for construction operations relating to works intended primarily for the benefit and use of the tenant that occupies or will occupy the property under the lease.

For the purposes of reg 20A, references to ‘landlord’ include:

• the person who has legal or beneficial ownership of the property;
• the person by whom the lease is granted or was granted at an earlier time; or
• the person who will grant a lease in the future where the executed an enforceable agreement to enter into that lease.

The introduction of reg 20A is a welcome development. The inclusion of payments from landlords to tenants within the CIS was an inadvertent side effect of the CIS being widely drafted to encompass all construction obligations and any related contract payments. There has never been a high risk of abuse or loss of tax revenue in relation to landlord to tenant payments and their inclusion within the CIS has resulted in a disproportionately high compliance burden for both landlords and tenants.

This issue has been exacerbated by the increasing trend of tenants carrying out more bespoke fit outs of their demise, and therefore, getting involved at an earlier stage of development at the property. This has led to landlords, for efficiency purposes, allowing or requesting tenants to carry out certain types of works at sites which would, traditionally, be considered as ‘landlord’s works’ or ‘CAT A works’, and the landlord funding such works by way of a capital contribution.

All such payments would invariably be within the scope of the CIS, regardless of amount and whether or not the landlord would ever benefit from those bespoke Cat A works. The CIS also does not have a group registration (unlike VAT) and therefore every landlord/tenant entity within a property holding structure needs to consider the CIS in isolation, and pursue the registration and compliance process separately.

The new reg 20A is particularly helpful to the large number of commercial landlords which fall within the wide definition of a ‘deemed contractor’ under the CIS legislation, as a result of the size of their portfolio of properties and the general refurbishment works that they inevitably undertake across their portfolio. Without reg 20A, those landlords have had to apply the CIS in respect of their leasehold transactions, where contributions to works have been made, and the fact patterns have, as noted above, invariably given rise to multiple complex issues resulting in significant time and finance costs for compliant taxpayers (large institutional landlords and large commercial businesses), not least because retail occupiers in most cases do not have, and would have had no reason to have applied for, CIS subcontractor gross payment status.

However, before the release of the HMRC guidance in mid-April 2024, there was much concern among advisers about the interpretation of the final limb of the reg 20A test, ie the requirement that the relevant works must be intended ‘primarily for the benefit and use of the tenant’. While, as we set out in more detail below, the guidance has proved to be helpful, it has not completely removed landlord/tenants payments from the scope of CIS.

Helpfully, reg 20 of the CIS Regulations 2005, which excludes reverse premiums from the scope of the CIS, has been retained. (A published draft version of the CIS Amendment Regulations 2024 provided for reg 20 to be removed, but this provision was not included in the final version of the CIS Amendment Regulations 2024, as a result of responses to HMRC’s technical consultation on the draft regulations, which included a response submitted by Eversheds Sutherland.)

HMRC’s new guidance

HMRC has now updated its Construction Industry Scheme Reform (CISR) Manual to reflect the recent changes to the CIS. In particular, CISR14048 and CISR14049 set out HMRC’s detailed view of the operation of the provisions in reg 20A.

Regulation 20A(1)(d)

In relation to the requirement in reg 20A(1)(d) that the tenant that occupies or will occupy the property will carry out the construction operations itself, or a third person will carry out
the construction operations under a contract with the tenant, CISR14048 states that:

• a contract means any legally binding agreement or arrangement, as explained further in CISR14020;
• the tenant may enter into contracts with one or more subcontractors to carry out the work. The subcontractors may themselves enter into contracts with other subcontractors to undertake the work but these payments would be within the scope of the CIS; and
• the landlord will need to satisfy themselves that there will be a contract in place for the work with a third person. This could be evidenced by way of a warranty given by the tenant to the landlord or the landlord requiring copies of any invoices.

Regulation 20A(1)(e)

In relation to the requirement in reg 20A(1)(e) that the payment is for construction operations relating to works intended primarily for the benefit and use of the tenant that occupies or will occupy the property under the lease, CISR14048 states that ‘occupation requires a physical presence with some degree of permanence, not simply a legal entitlement over the property’.

CISR14048 sets out HMRC’s view of the situations where the condition in reg 20A(1)(e) would or would not be met.

• If construction work is primarily for the benefit and use of the tenant but there are incidental benefits to the landlord or other tenants (which can include both Cat A landlord or Cat B (tenants) works), the condition would be met. However, where all occupiers of the property benefit and make use of the changes (for example, general refurbishment and upgrade of common areas used by all tenants in a building occupied by several tenants), the condition would not be met.
• If minor structural changes are required to install specific fixtures and fittings needed by the tenant, the condition would be met. However, the condition would not be met in relation to major structural changes or repairs to the fabric of the property or essential work required for any tenant to occupy the premises (for example replacement windows, significant roof repairs, installation of a new fire escape required under health and safety rules).
• Where all of the payment relates to construction work that is for the benefit and use of the tenant occupying or who will occupy the property, the condition will be met, but the condition will not be met if part of the payment is for construction work that is not for the benefit and use of the tenant occupying or who will occupy the property.
• Where the fit outs from a previous tenant must be removed before the new tenant specific fit outs can be made, the condition will be met, but the condition will not be met if the removal of fit outs from a previous tenant includes significant structural changes/building repairs.

Before the introduction of the new exemption in reg 20A, the key set of criteria that would need to be considered in order to determine whether withholding was required under the CIS would include (i) whether the landlord would normally be expected to carry out the works; (ii) whether there is an obligation on the tenant to carry out the works; (iii) whether the works are disregarded at rent review; and (iv) whether the works form part of the yielding up specification.

With the introduction of reg 20A, there will be many examples of landlord/tenant payments which would fall squarely within the scenarios set out in the new HMRC guidance. This is especially the case where there is a single occupancy building and any works (provided they are not major structural changes, repairs to the fabric of the property or essential works required to make the building safe for occupation) to the common areas could fall within reg 20A, where all common areas are in use by the same tenant.

CISR14049 goes on to outline some more detailed hypothetical scenarios in which HMRC consider reg 20A would or would not apply.

These scenarios include the following examples of works which HMRC consider may be carried out for the benefit of the tenant, depending on the circumstances:

• the installation of new interior walls and new floor boxes to meet the tenant’s business needs; and
• fitting out an office building to meet a tenant’s needs, including the installation of specialist plant (air conditioning units and servers) in a building’s plant room that requires some structural changes, new signage, the installation of a separate reception area and security gates, refurbishment of toilets used exclusively by the tenant and additional lockers and bike racks in the basement.

HMRC states that the payment in the following scenario involving sub-tenants would qualify under reg 20A, provided the other conditions are met:

‘A company agrees a lease with the owner of a building that permits the property to be sub-let. The head tenant intends to sub-let parts of the property. The owner agrees to pay the head tenant for the fit out works for the head tenant and the sub-tenants. The head tenant enters into a contract with a third person to do this work. The construction work is primarily for the benefit and use of the head tenant and the sub-tenants occupying the property under the head lease.’

However, HMRC states: ‘If the head tenant undertakes the construction work on the parts of the property it does not occupy the payment would not qualify under reg 20A as they do not occupy that part of the property and there is not a contract in place for the work.’

In any sub-letting scenario, unless the fact pattern sits squarely within HMRC’s example, careful consideration will need to be given.

Conclusion

Although the new reg 20A will exclude many landlord to tenant payments from the scope of the CIS, it will not apply to all such payments. Despite its helpful guidance, HMRC’s interpretation of the meaning of works ‘intended primarily for the benefit and use of the tenant’ is potentially narrower than expected, which means, in some cases, there will still be time-consuming work to be done in identifying the nature of the works and whom they benefit.

We can see the policy rationale for the government not providing a blanket exemption for landlord/tenant payments on the basis that this might leave the door open for abuse within the construction industry, where potential development licences could be turned into longer development leases under which construction payments are disguised as rent/capital contributions.

Therefore, parties to landlord to tenant payments which are potentially within the scope of the CIS should still take legal advice regarding whether reg 20A will apply to those payments and regarding how, where appropriate, the payments should be structured and appropriately documented to ensure they fall within reg 20A.