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The Construction Industry Scheme: Change in the air?

What does real estate investment have to do with the problem of tax evasion made possible by cash-in-hand payments in the building industry?  Very little, one might suspect, but that has not prevented real estate investors becoming the unintended casualty of a withholding tax introduced in the 1970s to target tax fraud among builders.  A concerted effort has now been made to lobby for sensible improvements, spearheaded by the Chartered Institute of Taxation.

The Construction Industry Scheme (CIS) requires deductions to be paid to HMRC when payments are made under certain construction contracts, similar to the way that employers are required to make deductions when operating payroll in respect of employment contracts.  By securing tax revenue at the source of payment, the risk of tax loss on undeclared income is reduced.

Two factors have resulted in the CIS becoming a misplaced administrative burden for real estate investment.

First, the law as written could apply very broadly, including (at least potentially) to situations where a landlord and tenant agree as part of lease negotiations that the tenant will undertake works going beyond ordinary fit-out works and which therefore benefit the landlord.  Any landlord’s contribution to those works may fall within the scope of the CIS.  The result has been large, institutional investors devoting material amounts of time and effort to comply with a counter-evasion regime at odds with the context in which they operate.

Second, HMRC’s commendable work engaging with taxpayers and providing bespoke rulings to make up for the deficiencies caused by that drafting has allowed the situation to remain just about tolerable for many years.  Nonetheless a great many landlord and tenant transactions have been subjected to disproportionate delays and additional costs as parties grapple with the CIS.

The Chartered Institute of Taxation has recently made a public submission to HMRC urging a change in the law that would make the CIS more targeted, removing ordinary landlord and tenant activity from its scope.  The submission is, in our view, an excellent piece of work and Hogan Lovells’ tax team has provided evidential support for it to HMRC.

The real estate sector will remain hopeful that HMRC applies the same energy to tackling this issue at its legal source as it has done in coping with its day-to-day fall-out.

A copy of the submission can be found here.