How a Limited Company Reclaims CIS Deductions (Including in Insolvency)

When a contractor in the supply chain enters administration or liquidation, the CIS deductions it has taken from a subcontractor's payments become a cash-recovery and evidence problem. The subcontractor has to prove the deductions were genuinely suffered, submit them through the right credit route, and separate the tax credit from the commercial debt owed by the failed contractor.

The risk is highest in labour-only or intermediary-heavy chains, where payment records, verification records, and CIS returns can be fragmented across several parties. That is why the due-diligence issues in intermediaries and umbrella companies in construction and the procedural route for appealing CIS monthly return penalties often need to be reviewed at the same time as the recovery claim.

How the CIS deduction-and-credit mechanism normally works

Under CIS, a contractor that pays a subcontractor under deduction takes tax from the payment, issues a payment and deduction statement (PDS) to the subcontractor, and pays the tax over to HMRC by the 22nd of the following month (19th by post). HMRC credits the deductions to the subcontractor through the route appropriate to its structure: a limited company offsets the deductions against its PAYE liabilities through the Employer Payment Summary, and a sole trader or partnership claims the deductions as a credit on its Self Assessment return.

The credit mechanism is built on the assumption that the contractor actually paid the deductions over. Where the contractor did not, but the subcontractor holds a valid PDS, HMRC will generally still credit the subcontractor and pursue the contractor (or its administrator or liquidator) for the unpaid tax. The PDS is the document that makes that credit possible, which is why the first practical step on insolvency is to confirm that PDSs were issued for the affected payments.

The role of the payment and deduction statement (PDS)

A PDS issued by the contractor sets out the gross payment, the materials component, the labour element, the CIS deducted, and the contractor's details. It is the evidence that the deduction was made. Without it, a subcontractor claiming a credit for deductions has nothing to underpin the claim, and HMRC may refuse the credit on the basis that the deduction cannot be evidenced.

In an insolvency context, this matters acutely. An administrator or liquidator taking over a failed contractor may not have, or may not be able to find, the records needed to reconstruct PDSs that were never issued. A subcontractor that did not insist on a PDS at the time of payment can find itself with no evidence of the deduction at exactly the moment the evidence is most needed.

What to do where PDSs are missing

Where a subcontractor knows it suffered deductions but cannot produce PDSs, the practical route is to reconstruct the evidence from bank statements (showing the net amounts received), the contracts and applications (showing the gross valuations), and the contractor's confirmation of the deductions taken. HMRC has historically been pragmatic where evidence is incomplete because of insolvency, provided the subcontractor can show the gross-to-net story and that the deductions were genuinely taken.

Limited company subcontractors: EPS set-off

A limited company subcontractor reports the CIS deductions suffered in the period through the monthly Employer Payment Summary (EPS) submission. The deductions are set off against the company's PAYE, NIC, student loan, and CIS liabilities for the tax month. Where the deductions exceed the liabilities in a month, the surplus is carried forward and set off in subsequent months until the surplus is exhausted or the tax year ends.

At the end of the tax year, any unrelieved CIS deductions can be reclaimed from HMRC as a cash repayment. The reclaim is made by the company through the appropriate online route once the year-end final EPS has been submitted. For a company that has been operating under deduction at scale, the year-end reclaim can be substantial and the timing of the cash repayment matters to working capital.

Sole trader and partnership subcontractors: Self Assessment credit

A sole trader or partnership subcontractor claims the CIS deductions as a tax credit on its Self Assessment return for the relevant tax year. The deductions are entered in the CIS box on the SA return; the credit reduces the income tax liability, and any excess is repaid by HMRC. The repayment comes through the usual Self Assessment refund cycle, which means the cash arrives months after the deduction was taken even in a clean case.

In an insolvency case, the SA route can be slower if HMRC investigates whether the deductions were actually paid over by the failed contractor before crediting the subcontractor. A complete documentary file (PDSs, bank statements, applications, contract papers) supports a faster credit and reduces the risk of HMRC challenge.

When the contractor never paid the deductions over

The substantive question in many insolvency cases is whether HMRC will credit the subcontractor for deductions that the failed contractor never paid over. The general position is that a subcontractor with a valid PDS is entitled to the credit and HMRC pursues the unpaid tax from the contractor or its insolvency office holder. The subcontractor should not, in principle, suffer the loss of cash that was withheld from its payment.

In practice there can be friction. HMRC may ask for additional evidence where the contractor's records are incomplete. The administrator or liquidator may need to confirm the deductions as a matter of fact. There can be timing delays while HMRC works through the position. The subcontractor's best protection is to provide a clear evidence pack proactively and to follow up persistently rather than waiting for the position to resolve itself.

The set-off mechanism and gross HMRC liabilities

There is a separate and sometimes confused point about set-off where the failed contractor owes HMRC for unpaid CIS and the subcontractor is itself owed money by the failed contractor. The CIS deductions suffered by the subcontractor are a credit to the subcontractor against its own tax liabilities; they are not a direct set-off against the failed contractor's debt to the subcontractor for the underlying invoice value. The subcontractor's commercial claim against the failed contractor is a separate matter handled through the insolvency process as an unsecured creditor.

This distinction matters because subcontractors sometimes assume that the deductions suffered automatically reduce the loss they have taken on the failed contract. They do, but only to the extent the tax credit comes through HMRC. The commercial debt for the gross invoice value remains owed by the failed contractor, with whatever recovery the insolvency process delivers.

Disputed deductions and HMRC challenge

Where HMRC challenges the credit claimed by a subcontractor, common grounds include: PDSs that do not match the contractor's records, deductions on payments that should not have been within CIS at all, materials elements that were not correctly stripped out, and timing differences between when the deduction was made and when the PDS was issued. Each of these can be resolved with documentation, but the resolution takes time and the cash repayment is held up while it runs.

Where the challenge cannot be resolved by correspondence, the formal route is an internal review of the HMRC decision followed, if necessary, by an appeal to the First-tier Tribunal (Tax). The appeal route is slow and proportionate cost considerations apply, but it is available where the amount at stake justifies it.

A practical recovery sequence

The steps below are the sequence specialist advisers typically work through when a contractor in the chain enters insolvency.

1. 1Identify every payment made by the failed contractor to you in the affected period, gross and net.
2. 2Locate the PDSs for each payment and confirm they are complete; reconstruct any missing ones from bank and contract records.
3. 3Contact the administrator or liquidator in writing requesting confirmation of CIS deductions taken and returns filed.
4. 4Submit the deductions through your normal route: EPS for a limited company, SA return for a sole trader or partnership.
5. 5Respond promptly to any HMRC query with the supporting documentation.
6. 6Track the commercial debt for the gross invoice value separately, as an unsecured creditor claim in the insolvency.
7. 7Escalate via statutory review and tribunal where HMRC refuses the credit on documented deductions.

Worked example: deductions taken, contractor liquidated before payover

A limited company subcontractor with three valuations paid net of CIS by a contractor that subsequently entered creditors' voluntary liquidation before paying the deductions over to HMRC.

In this example the total £21,000 of deductions feeds through the company's EPS submissions and offsets its PAYE liabilities. The gross labour value owed for the unpaid invoices remains an unsecured creditor claim in the liquidation, with recovery dependent on the dividend the insolvency delivers to unsecured creditors.

How to reduce the exposure before it arises

Subcontractors with significant exposure to a single contractor can manage the insolvency risk before it crystallises. The headline controls are routine but the discipline matters.

• Insist on a PDS with every payment, not retrospectively at the end of a contract or year.
• Reconcile PDSs to bank receipts monthly so any discrepancy surfaces while the contractor is still trading.
• Run credit checks on substantial contractors at engagement and periodically through the relationship.
• Spread exposure across more than one major contractor where the work mix allows it.
• Hold a clean record of contracts, applications, valuations, and PDSs that can be produced quickly if needed.

Common questions

Do we lose the credit if the contractor never filed CIS300 returns?

Not necessarily. The credit depends on the deductions actually having been made, evidenced by the PDS and the gross-to-net story. HMRC will generally credit a subcontractor that can evidence the deductions even where the contractor failed to file returns, and pursue the contractor or its insolvency office holder separately for the missing returns and unpaid tax.

How long do we have to claim?

For a limited company, the EPS set-off operates monthly and the year-end reclaim crystallises the position once the final EPS is submitted. For a sole trader or partnership, the credit goes on the SA return for the relevant tax year. Time limits apply to amendments and overpayment claims, so do not let the deductions sit unclaimed across tax years.

Can we set off the deductions against the contractor's debt to us?

No. The CIS deductions are a tax credit against your own HMRC liabilities, not a set-off against the contractor's debt to you for the invoice. The commercial debt is dealt with separately through the insolvency process.

Do we need a solicitor?

Routine recoveries through EPS or SA do not need legal input. Where HMRC challenges the credit or the amounts are significant, specialist tax advice and, in some cases, legal input on the insolvency interaction can be worthwhile.