Summary
CIS and PAYE answer two different questions that tradespeople frequently conflate. PAYE is how you pay someone who is your employee. CIS is how a contractor deducts tax at source from a genuinely self-employed subcontractor operating in the construction sector. The scheme you use is not a choice you make for administrative convenience or to save on employer's National Insurance — it's determined by the underlying employment status of the person doing the work, and HMRC (and, in a dispute, an employment tribunal) will look past whatever label the paperwork uses to the reality of how the work is actually organised and controlled.
This matters because construction has a long history of "disguised employment" — engaging someone who works exclusively for one contractor, at times and in a manner the contractor dictates, using the contractor's tools and materials, with no meaningful ability to send a substitute or turn down work, but labelling them "self-employed" and paying them under CIS to avoid employer's National Insurance, holiday pay, sick pay, pension auto-enrolment, and other employment law obligations. HMRC actively investigates this, and the financial exposure for getting it wrong sits with the engaging business, not the worker.
The correct process is to assess employment status first, using the recognised legal tests, and only then decide whether the person is paid as an employee (PAYE) or as a genuinely self-employed CIS subcontractor. Doing it the other way round — deciding "I want to pay this person as self-employed" and then trying to make the facts fit — is the single most common and costly mistake small construction businesses make.
Key Facts
- CIS applies to "construction operations" — a broad statutory definition covering most building, civil engineering, alteration, repair, and demolition work, with specific exclusions (e.g. professional services like architecture and surveying carried out in an advisory capacity, and some off-site manufacturing).
- CIS deduction is on labour only — the deduction is calculated on the labour element of a payment; the verified cost of materials the subcontractor has genuinely incurred is excluded from the deduction calculation.
- Standard CIS deduction rate: 20% — applies to subcontractors registered with HMRC for CIS.
- Higher CIS deduction rate: 30% — applies to subcontractors who are not registered or cannot be verified by HMRC.
- Gross Payment Status: 0% deduction — subcontractors who meet HMRC's business, turnover and compliance tests can apply for Gross Payment Status, receiving payments with no CIS deduction and settling their tax liability through Self Assessment or Corporation Tax instead. **** — the specific turnover threshold and the compliance test criteria have been amended by HMRC in recent years (including changes to what counts against the compliance test); confirm the current figures directly on GOV.UK or with an accountant before advising a subcontractor on eligibility.
- Verification requirement — a contractor must verify a new subcontractor with HMRC (via the CIS online service or commercial payroll/CIS software) before making the first payment, to establish the correct deduction rate.
- Monthly CIS returns (CIS300) — contractors must file a monthly return of all subcontractor payments and deductions, due by the 19th of the month following the tax month in which payments were made; penalties apply for late filing even where no subcontractors were paid that month if the contractor remains registered.
- CIS does not determine employment status — being CIS-registered, or having tax deducted under CIS, has no bearing on whether someone is legally employed or self-employed. Status is determined independently by case law tests, and a worker can be wrongly paid under CIS despite actually being an employee.
- The three-limb test (Ready Mixed Concrete v Minister of Pensions and National Insurance [1968] 2 QB 497) — the foundational employment status test: (1) personal service — the worker must provide their own work and skill; (2) control — the engager has sufficient control over how, when and where the work is done; (3) other contractual provisions are consistent with employment rather than a genuine business relationship.
- Substitution — a genuine, unfettered right for the worker to send someone else to do the work in their place, exercised in practice and not just written into a contract, is one of the strongest indicators of self-employment. A "sham" substitution clause that's never actually usable doesn't establish self-employment.
- Mutuality of Obligation (MOO) — whether the engager is obliged to offer work and the worker is obliged to accept it; a genuine self-employed subcontractor can decline work without penalty and isn't guaranteed further work.
- Autoclenz Ltd v Belcher [2011] UKSC 41 — Supreme Court authority establishing that a written contract's stated terms do not override the actual reality of the working relationship if the two conflict; courts and tribunals look at what actually happens on the ground, not just what the paperwork says.
- HMRC's CEST tool (Check Employment Status for Tax) — a free online tool to help assess employment status; useful as a starting point but not legally binding, and has been criticised (including in tribunal decisions) for not adequately capturing Mutuality of Obligation.
- Off-payroll working rules (IR35, Chapter 10 ITEPA 2003) — primarily relevant where a subcontractor operates through their own personal service company (limited company) rather than as a sole trader; medium and large private-sector engaging businesses became responsible for determining the status of such workers from 6 April 2021, shifting liability risk onto the engager in many cases.
- Consequences of misclassification — if HMRC or a tribunal determines a "self-employed" CIS subcontractor was actually an employee, the engaging business can become liable for unpaid PAYE income tax and both employer's and employee's National Insurance contributions, plus penalties and interest, and the worker may separately bring employment tribunal claims (unlawful deduction from wages, holiday pay, national minimum wage, unfair dismissal if sufficiently long service) regardless of the tax outcome.
- Domestic Reverse Charge VAT for Construction Services — since 1 March 2021, for standard or reduced-rated construction services supplied between two VAT-registered, CIS-registered businesses (not to an end user), the customer accounts for VAT to HMRC instead of the supplier charging it — a separate but frequently intersecting compliance requirement on the same invoices as CIS deductions.
- Written contracts — a written subcontractor agreement is good practice and evidence of intent, but is not conclusive if the actual working arrangement (control, exclusivity, tools, substitution in practice) contradicts what the contract says.
Quick Reference Table
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Try squote free →| Factor | Employee (PAYE) | Genuinely Self-Employed Subcontractor (CIS) |
|---|---|---|
| Who deducts tax | Employer, via PAYE on gross wages | Contractor deducts CIS from labour element only |
| National Insurance | Employer's and employee's NI both apply | No employer's NI; subcontractor pays Class 2/4 NI via Self Assessment |
| Right of substitution | No — must do the work personally | Yes, genuine and exercised in practice |
| Control over how/when work is done | High — employer directs | Low — subcontractor decides method, often has own tools |
| Mutuality of obligation | Employer must offer work, employee must accept | No obligation either way — can decline jobs |
| Holiday pay, sick pay, pension auto-enrolment | Statutory entitlement applies | Not applicable — subcontractor manages own provision |
| Own tools and equipment | Usually employer-provided | Usually subcontractor's own |
| Financial risk | None — paid regardless of job outcome | Genuine risk — can lose money on a fixed-price job |
| Works for multiple clients | Often works for one employer only | Typically works for multiple contractors/clients |
| Tax deduction rate | Per PAYE tax code, cumulative | 20% (registered) / 30% (unverified) / 0% (Gross Payment Status) |
| Deducted from | Full gross pay | Labour element only (materials excluded) |
| Who files the return | Employer files RTI (Real Time Information) | Contractor files monthly CIS300 return |
| Employment rights on termination | Full statutory protection (subject to qualifying service) | Governed by the commercial contract only |
Detailed Guidance
Assessing status before deciding on CIS or PAYE
Work through the recognised tests before deciding how to pay someone, not after. Ask: does this person have a genuine, exercised right to send a substitute? Do they control how, when, and with what tools they do the work, or do you? Are they free to decline a job without consequence, and do you have no obligation to offer them further work? Do they work for other contractors as well as you, and do they carry their own financial risk (fixed-price work where they can lose money, their own public liability insurance)? A "yes" pattern across these points supports self-employment and CIS; a "no" pattern — personal service required, your control over method and hours, an ongoing expectation of work on both sides, exclusivity, your tools — points toward employment and PAYE, whatever label is on the paperwork.
Why the contract wording isn't enough
Following Autoclenz v Belcher, a written agreement stating someone is a "self-employed subcontractor" carries little weight if the actual working relationship contradicts it. A common and costly mistake is treating a signed subcontractor agreement as a complete defence — it's evidence of intent, useful evidence but not a shield, and tribunals and HMRC will look at how the relationship actually operated day to day: who set the hours, who could refuse a job, who provided tools, whether the person worked exclusively for one contractor for a sustained period.
Verifying a subcontractor for CIS
Before paying a new subcontractor for the first time, verify them with HMRC through the CIS online service or commercial CIS/payroll software, providing their Unique Taxpayer Reference (UTR), National Insurance number (for individuals) or company details. HMRC returns the correct deduction rate — 0%, 20%, or 30% — which the contractor must apply. Keep a record of the verification result; getting this step wrong (applying 20% to an unverified subcontractor, for example) is a compliance failure that surfaces in a CIS review or audit.
Separating labour and materials on an invoice
CIS deduction applies only to the labour element of what a subcontractor charges. A subcontractor's invoice should clearly separate the cost of materials they've genuinely purchased and incurred from their labour charge; the contractor deducts CIS tax only from the labour figure. Materials bundled into a single lump-sum figure without a breakdown can lead to the contractor over-deducting (deducting CIS on materials cost, which shouldn't happen) or under-deducting if challenged later — always require an itemised invoice from CIS subcontractors.
Gross Payment Status
Subcontractors who meet HMRC's business test, turnover test, and compliance test can apply for Gross Payment Status, meaning contractors pay them with no CIS deduction at all, and the subcontractor settles their full tax liability through Self Assessment (sole trader/partnership) or Corporation Tax (limited company) instead. This significantly improves a subcontractor's cash flow but comes with a stricter compliance burden — late filing or late payment of their own tax obligations can result in HMRC withdrawing Gross Payment Status. **** before advising a subcontractor whether they're likely to qualify, as HMRC has adjusted the compliance test criteria in recent years.
Managing the risk of a misclassification finding
If HMRC successfully argues that a "CIS subcontractor" was actually an employee, the engaging business typically becomes liable for the PAYE income tax and both employee's and employer's National Insurance that should have been deducted, generally with penalties and interest on top — recovering this from the worker afterwards is rarely straightforward. Separately, the worker can bring an employment tribunal claim regardless of what HMRC decides on the tax side — the two processes use related but not identical tests, and someone can be found a "worker" for employment rights purposes without being an "employee" for PAYE purposes. **** — review engagement structures periodically, ideally with an accountant or employment law specialist, particularly for anyone working exclusively for one contractor over a sustained period.
Off-payroll working (IR35) where a subcontractor uses a limited company
Where a subcontractor operates through their own personal service company rather than as a sole trader, the off-payroll working rules (Chapter 10, ITEPA 2003) may apply instead of, or alongside, the ordinary tests. Since 6 April 2021, medium and large private-sector businesses engaging such contractors are generally responsible for determining the contractor's deemed employment status and deducting PAYE/NIC accordingly. Small businesses (meeting Companies Act 2006 small company thresholds) are currently exempt, with the contractor's own company remaining responsible for its status instead. **** as these are periodically updated.
Frequently Asked Questions
Can I just ask a subcontractor to sign a self-employment agreement to protect my business?
No, not on its own. A signed agreement is useful supporting evidence but is not determinative if the actual working relationship — control, exclusivity, lack of genuine substitution, mutuality of obligation — looks like employment. HMRC and employment tribunals will look past the contract wording to how the work genuinely operates. The protection comes from structuring the actual working relationship correctly, not from the paperwork alone.
If someone works for me regularly, does that automatically make them an employee?
Not automatically, but regularity is one factor tribunals weigh alongside the others. A subcontractor who works for you most weeks but genuinely retains the right to decline jobs, works for other contractors too, brings their own tools, and carries financial risk on fixed-price work can still be genuinely self-employed. The risk increases significantly where the relationship becomes exclusive, long-running, and the contractor effectively directs the person's working pattern as if they were staff.
What's the difference between CIS deduction and PAYE tax for the worker's own finances?
A CIS deduction is an advance payment toward the subcontractor's eventual Self Assessment tax bill, not a final tax calculation — the subcontractor still files a Self Assessment return, and CIS deductions already made are offset against the tax actually owed, with any overpayment refunded. PAYE, by contrast, is calculated against the specific employee's tax code and is generally close to their final liability for that employment income, with employer's NIC an entirely separate cost the employer bears on top.
Do I need to register for CIS if I only occasionally use subcontractors?
If your business pays subcontractors for construction operations, or if your own business spends above HMRC's threshold on construction as part of a wider (non-construction) business, you're likely required to register as a CIS contractor. **** on GOV.UK, since the rules distinguish between mainstream construction contractors and "deemed contractors" (non-construction businesses with high construction spend) with different registration triggers.
Is it acceptable to pay someone as self-employed at first and move them to PAYE later if the relationship changes?
Yes, and this is often exactly the right approach — employment status isn't fixed forever; it reflects the current reality of how the relationship operates. If a subcontractor who started genuinely self-employed gradually becomes exclusive to your business, works your set hours, and stops taking other work, the correct response is to reassess and move them onto PAYE at that point, not to keep paying them under CIS because that's how the relationship started.
Regulations & Standards
Finance Act 2004, Part 3, Chapter 3 — the statutory basis for the Construction Industry Scheme.
Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003), Chapter 10 — off-payroll working rules (IR35) for engagements via personal service companies.
Employment Rights Act 1996 — statutory employment rights (unfair dismissal, unlawful deduction from wages) that can apply where a worker is found to be an employee or "worker."
National Minimum Wage Act 1998 — minimum wage entitlement applicable to employees and, in many circumstances, "workers."
Working Time Regulations 1998 — governs statutory holiday entitlement, relevant where misclassification is found.
Value Added Tax Act 1994 (as amended) — Domestic Reverse Charge for Building and Construction Services (from 1 March 2021) — VAT accounting mechanism intersecting with CIS-registered B2B construction supplies.
Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968] 2 QB 497 — foundational case law establishing the three-limb employment status test.
Autoclenz Ltd v Belcher [2011] UKSC 41 — Supreme Court authority that the reality of the working relationship overrides contradictory written contract terms.
GOV.UK — Construction Industry Scheme (CIS) — official CIS registration, deduction rates and return guidance
GOV.UK — Employment status — official guidance and the CEST tool for assessing worker employment status
HMRC — Off-payroll working rules (IR35) — Chapter 10 ITEPA 2003 guidance for engaging businesses
GOV.UK — Gross Payment Status — eligibility criteria for CIS Gross Payment Status
ACAS — Employment status — plain-English guidance on employee, worker and self-employed distinctions
cis scheme — CIS deduction rates, gross payment status thresholds and CIS300 monthly return process
subcontractors — employment status tests, HMRC CEST tool, IR35 in construction, PAYE liability risk
subcontracting — CIS deduction rates, labour vs materials split, domestic reverse charge VAT interaction
sole trader vs limited company — structuring a subcontracting business as sole trader vs limited company