Court of Appeal considers HMRC's CIS powers and allows taxpayers' appeals

In Beech Developments (Manchester) Ltd & Ors v HMRC [2024] EWCA Civ 486, the Court of Appeal allowed the taxpayers' appeals and confirmed that HMRC does have the power to issue 'non-liability directions' under the Construction Industry Scheme (CIS).

Background

Beech Construction Partnership Ltd (BCPL), the main contractor on several construction projects, operated the CIS on the sub-contracts it made.  BCPL was also a sub-contractor on various contracts with six related entities which, for convenience, are referred to collectively in this article as 'Beech'. Beech failed to operate the CIS in respect of payments made to BPCL.  HMRC therefore issued determinations to Beech, under regulation 13 of the Income Tax (Construction Industry Scheme) Regulations 2005 SI 2005/2045 (the regulations). The determinations were appealed to the First-tier Tribunal and have been stayed pending the outcome of the judicial review proceedings instigated by Beech and the subject of this decision.

The CIS is designed to reduce the risk of evasion by construction industry workers. In outline, it does so by requiring contractors s who carry on construction business to make deductions from payments to sub-contractors engaged by them and account for the amounts deducted to HMRC. The cost of materials is excluded so that the deduction is confined to the element attributable to labour. Amounts so deducted are then available for credit against the sub-contractor's own liabilities. The rate of deduction is determined by the status of the sub-contractor. If the sub-contractor is not registered with HMRC the rate is 30% and if the sub-contractor is registered the rate is 20%. However, if certain conditions are met it is possible to register for gross payment, in which case no deduction is made.

Where, contrary to the terms of the legislation, no deduction, or an insufficient deduction, is made from a payment to a sub-contractor not registered for gross payment, the contractor must still account to HMRC for the amount that should have been deducted. If they do not do so then HMRC may make a determination of the amount in question under regulation 13 of the regulations. Further, and unsurprisingly given that no deduction has been suffered, there is no provision that permits the sub-contractor to obtain a credit against their own liabilities for amounts that the contractor is required to pay but which have not been deducted. However, where the sub-contractor does in fact meet their own tax liabilities the mischief at which the CIS is aimed is not only not present, but without more HMRC would receive and retain a greater sum than it would have been entitled to had the correct deduction been made. Alternatively, the contractor may have taken care to comply with the CIS regime but made an innocent mistake and be left out of pocket.

Regulation 9 of the regulations recognises these possibilities by providing a mechanism that empowers HMRC, if certain conditions are satisfied (referred to as condition A or condition B), to issue a direction to the effect that the contractor is not required to pay. HMRC's interpretation of the regulations has been that there is no power to issue a direction under regulation 9 if a determination has already been made, under regulation 13, of the amount in question. 

Beech challenged, by way of judicial review proceedings, HMRC’s interpretation of regulation 9 that it cannot be invoked after a determination made under regulation 13 and argued that regulation 9 remains applicable until a determination becomes final. 

Having been unsuccessful before the Administrative Court, Beech appealed to the Court of Appeal.

Court of Appeal judgment

The appeal was allowed.

The Court concluded that HMRC has the authority to issue a direction under regulation 9 concerning amounts already subject to a determination under regulation 13, provided the determination remains open for adjustment. The Court clarified that if a regulation 9 application is properly raised as a ground of appeal, it can prevent the determination from becoming final, thereby allowing for adjustments under regulation 13(3) to account for any direction issued by HMRC. Accordingly, Beech's appeal was allowed and HMRC’s refusal to consider Beech's claim under regulation 9(4) was quashed, enabling Beech to claim relief under regulation 9.

Comment 

The Court of Appeal noted that if the order of events had been different and if HMRC's interpretation was correct, there would be a potential windfall for HMRC. For example, in circumstances where a sub-contractor pays their own tax liabilities, but the contractor also pays the same tax following a determination, HMRC could refuse to issue a direction waiving the contractor's liability. Clear words would be needed in the legislation to justify such a windfall, especially since the mischief intended to be addressed by the CIS would not exist in such a scenario. This decision overturns a number of previous decisions that had supported HMRC's interpretation of the regulations.

On a practical note, it is clear from this decision that a contractor who receives a regulation 13 determination must respond quickly. They will need to appeal the determination and apply for a regulation 9 direction. Time is of the essence, as once the regulation 13 determination is finalised, a regulation 9 direction will have no effect.

The decision can be viewed here.