CIS and VAT: How They Work Together

If you work in the construction industry, there's a good chance you need to deal with both the Construction Industry Scheme and VAT. On their own, each system is manageable enough. But when you need to apply both at the same time — particularly with the domestic reverse charge for VAT thrown into the mix — things can get confusing very quickly.

I'm Penny, the AI bookkeeper at Accounted, and in this guide I'll break down how CIS and VAT work together, explain the domestic reverse charge, and help you get your invoicing right.

CIS and VAT: The Basics

Let's start with the fundamentals. CIS and VAT are two completely separate systems that happen to apply to many of the same transactions in construction.

CIS requires contractors to deduct a percentage (20% or 30%) from the labour portion of payments to subcontractors and pass those deductions to HMRC. The deductions are advance payments of the subcontractor's income tax.

VAT is a consumption tax charged on the supply of goods and services. If you're VAT registered{target="_blank" rel="noopener noreferrer"} and your construction services are standard-rated (which most are), you charge VAT at 20% on your invoices and account for it through your VAT return.

The important principle to remember is: CIS deductions are calculated on the amount before VAT. The VAT element of an invoice is never subject to CIS deductions. These are handled through completely separate channels — CIS deductions go through the CIS system, and VAT goes through the VAT return system.

A Simple Example (Without Reverse Charge)

Before the domestic reverse charge was introduced, a straightforward CIS and VAT calculation looked like this:

• Labour: £1,000
• Materials: £300
• Subtotal: £1,300
• VAT at 20%: £260
• Invoice total: £1,560
• CIS deduction (20% of labour): £200
• Amount paid to subcontractor: £1,360 (£1,560 - £200)

The subcontractor would then account for the £260 VAT through their VAT return, and the £200 CIS deduction would be offset against their income tax.

The Domestic Reverse Charge for VAT

In March 2021, HMRC introduced the domestic reverse charge for construction services. This fundamentally changed how VAT works for many transactions in the construction supply chain — and it has a direct impact on how CIS and VAT interact.

What Is the Reverse Charge?

Under the normal VAT rules, the supplier (subcontractor) charges VAT on their invoice and pays it to HMRC. The customer (contractor) pays the VAT to the supplier and then reclaims it as input tax on their own VAT return.

Under the reverse charge, this is flipped. The supplier does not charge VAT on their invoice. Instead, the customer accounts for the VAT on the supply through their own VAT return — they charge themselves the VAT (as output tax) and simultaneously reclaim it (as input tax), effectively cancelling it out.

The reverse charge was introduced to combat VAT fraud in the construction sector, where some businesses were charging VAT but then disappearing without paying it to HMRC (known as "missing trader" fraud).

When Does the Reverse Charge Apply?

The domestic reverse charge applies when all of the following conditions are met:

1. The supply is of construction services that fall within the scope of CIS{target="_blank" rel="noopener noreferrer"}
2. Both the supplier and the customer are VAT registered
3. The supply is reported under CIS
4. The customer is not an "end user" or "intermediary supplier"

The last point is crucial. If the contractor is the final customer for the construction work (an end user) — for example, a property developer having their own building constructed — the reverse charge does not apply, and normal VAT rules are used instead.

Similarly, if you're a contractor who makes onward supplies that are not construction services, you may qualify as an intermediary supplier, and the reverse charge wouldn't apply to the supplies you receive.

How It Affects CIS Calculations

When the reverse charge applies, the CIS deduction calculation is slightly different because there's no VAT on the invoice.

Example with reverse charge:

• Labour: £1,000
• Materials: £300
• Subtotal (no VAT charged): £1,300
• CIS deduction (20% of labour): £200
• Amount paid to subcontractor: £1,100 (£1,300 - £200)

Compare this to the earlier example where the subcontractor would have received £1,360 (including the £260 VAT). Under the reverse charge, the subcontractor receives £260 less upfront because they're not collecting VAT from the contractor. They'll instead need to manage this through their VAT return.

This has a significant cash flow impact for subcontractors, which we'll discuss more below.

Invoicing Under CIS and the Reverse Charge

Getting your invoices right is essential when CIS and VAT both apply. Errors in invoicing can cause problems with both HMRC systems and create difficulties for everyone in the supply chain.

What Your Invoice Must Include

When the reverse charge applies, your invoice must:

• Clearly state that the domestic reverse charge applies
• Show the rate of VAT that applies (usually 20%) — even though you're not charging it
• Not include a VAT amount in the total
• Include the note: "Customer to account for the reverse charge output tax of £[amount] at the rate of [rate]%"
• Separate labour and materials (for CIS deduction purposes)
• Include your CIS registration details

Invoice Example

Here's how a properly formatted reverse charge CIS invoice might look:

| Item | Amount | |------|--------| | Labour — plastering work at 123 High Street | £2,000 | | Materials — plaster, bonding, mesh | £500 | | Subtotal | £2,500 | | VAT at 20% (reverse charge — customer to account) | £0 | | Total due | £2,500 | | CIS deduction at 20% (on labour of £2,000) | -£400 | | Amount payable | £2,100 |

Note: "Domestic reverse charge applies. Customer to account for reverse charge output tax of £500 at 20%."

When the Reverse Charge Doesn't Apply

If the reverse charge doesn't apply (for example, because your customer is an end user), you invoice with VAT as normal:

| Item | Amount | |------|--------| | Labour — plastering work at 123 High Street | £2,000 | | Materials — plaster, bonding, mesh | £500 | | Subtotal | £2,500 | | VAT at 20% | £500 | | Total due | £3,000 | | CIS deduction at 20% (on labour of £2,000) | -£400 | | Amount payable | £2,600 |

It's the subcontractor's responsibility to determine whether the reverse charge applies to each supply. If you're unsure, the safest approach is to ask your customer to confirm their status in writing. For more on how the reverse charge works, see our detailed guide on the domestic reverse charge for VAT in construction.

Cash Flow Implications

The combination of CIS deductions and the reverse charge can significantly impact cash flow, particularly for subcontractors.

For Subcontractors

Under the old rules, a VAT-registered subcontractor would collect VAT from the contractor and hold it until their next VAT return — effectively an interest-free short-term loan. Under the reverse charge, that VAT is never collected, reducing the subcontractor's incoming cash flow.

Combined with the 20% CIS deduction on labour, a subcontractor can end up receiving substantially less than the gross value of their work in the short term.

Example:

On a £10,000 labour-only invoice:

• Old rules: Receive £10,000 + £2,000 VAT - £2,000 CIS deduction = £10,000 cash received (VAT of £2,000 owed to HMRC later)
• Reverse charge: Receive £10,000 - £2,000 CIS deduction = £8,000 cash received

That's a £2,000 difference in immediate cash flow. Over a year, this can add up to tens of thousands of pounds.

For Contractors

Contractors actually benefit from the reverse charge in cash flow terms. They no longer pay VAT upfront to subcontractors and then wait to reclaim it on their VAT return. Instead, the reverse charge mechanism means the VAT cancels out on their own return.

VAT Return Adjustments

Subcontractor's VAT Return

When the reverse charge applies, the subcontractor does not include the VAT amount in their Box 1 (output tax) figure. The supply is included in Box 6 (total value of sales) at the net value, but no output VAT is declared on it.

This means the subcontractor's VAT return may regularly show a repayment position (more input VAT than output VAT), particularly if they have significant VAT on their own purchases and expenses but much of their sales are under the reverse charge.

Contractor's VAT Return

The contractor accounts for the reverse charge by including the VAT amount in both Box 1 (output tax) and Box 4 (input tax). This means it cancels out — you're charging yourself the VAT and immediately reclaiming it. The net value of the purchase goes in Box 7 (total value of purchases).

Common Mistakes When CIS and VAT Overlap

1. Applying CIS Deductions to the VAT Element

CIS deductions should only apply to the net amount (before VAT). If a contractor mistakenly calculates the 20% deduction on the VAT-inclusive figure, the subcontractor will have too much deducted. Always calculate CIS deductions on the pre-VAT amount.

2. Charging VAT When the Reverse Charge Applies

If the reverse charge applies and you charge VAT on your invoice, the contractor shouldn't pay it — and if they do, it creates problems for both parties' VAT returns. Make sure you understand when the reverse charge applies and invoice accordingly.

3. Not Applying the Reverse Charge When Required

The reverse situation is equally problematic. If you should be using the reverse charge but instead charge VAT normally, HMRC could pursue the contractor for the output tax while the subcontractor has already paid it — leading to potential double taxation and subsequent refund claims.

4. Confusing CIS Materials and VAT Input Tax

The materials deduction for CIS purposes and the input VAT on materials are two different things. Just because materials are excluded from CIS deductions doesn't affect how VAT is handled on those materials. Make sure you're treating materials correctly under CIS and separately handling the VAT correctly.

How Accounted Handles CIS and VAT Together

Managing CIS deductions and VAT — including the reverse charge — across dozens of invoices and multiple contractors is exactly the kind of complexity that accounting software should handle for you. Accounted automatically determines whether the reverse charge applies, calculates CIS deductions on the correct amounts, and formats your invoices properly.

Your VAT return data is compiled automatically, with reverse charge transactions categorised correctly. And if you're ever unsure about a specific transaction, you can ask me — I'll help you work out the right treatment.

Want to stop worrying about whether your CIS and VAT calculations are correct? Try Accounted and see how much easier it can be.

Key Takeaways

• CIS deductions are always calculated on the pre-VAT amount — never include VAT in the deduction calculation
• The domestic reverse charge means many subcontractors no longer charge VAT on construction invoices
• When the reverse charge applies, the contractor accounts for the VAT through their own VAT return
• The reverse charge significantly impacts subcontractor cash flow — plan accordingly
• Invoices must clearly state whether the reverse charge applies and include the correct notation
• The flat rate VAT scheme requires special treatment for reverse charge supplies
• Getting the CIS and VAT interaction wrong can trigger penalties from both systems — use software that handles it correctly

Accounted supports CIS — track deductions, verify subcontractors, and file returns directly to HMRC. See CIS support →