Two systems, one industry
Construction workers get paid through one of two systems. PAYE is the standard payroll system for employees: the paying contractor or agency calculates income tax and National Insurance each pay period, takes the deductions, and passes the net amount to the worker. CIS (the Construction Industry Scheme) is the system for self-employed subcontractors: the paying contractor deducts a fixed percentage from the labour portion of the invoice and forwards it to HMRC as an advance against the subcontractor's tax and National Insurance.
The systems serve different relationships and different legal statuses. Understanding how each one actually works, not just the headline rate, is important before making any decision about how you structure your work. This guide takes both systems apart and puts them side by side. For a broader explanation of how CIS operates as a scheme, see our guide to what is the Construction Industry Scheme.
How PAYE works for construction workers
If you are employed, whether directly on the tools for a main contractor or on the books of a labour agency, your wages go through PAYE. Your employer uses a tax code, assigned by HMRC, to spread your personal allowance (£12,570 for 2026/27) across the pay periods of the year. Income tax is deducted at 20% on earnings between the personal allowance and £50,270 (the basic rate band), and at 40% above that. Employee National Insurance (Class 1) is deducted at 8% on earnings between £12,570 and £50,270, and 2% above.
The employer also pays employer National Insurance at 15% on earnings above £5,000 per year. That cost sits with the employer and does not come out of the worker's gross wage directly, but it does affect the total cost of employment, which influences what rates agencies can offer.
Because the personal allowance is factored in throughout the year, a PAYE worker broadly pays the right amount of tax as they go. Large refunds are uncommon unless someone changes jobs mid-year, has multiple employments, or claims expenses not covered through the payroll.
How CIS works for self-employed subcontractors
Under CIS, a contractor deducts a flat percentage from the labour element of a subcontractor's payment before passing on the remainder. The deduction acts as an advance against the subcontractor's eventual income tax and Class 4 National Insurance bill for the year.
The key technical point: CIS deductions apply to the labour element only. The cost of materials the subcontractor buys for the job is excluded from the deduction base. So an invoice for £1,000 made up of £700 labour and £300 materials attracts the deduction on the £700, not the full £1,000. This distinction is one of the most commonly misunderstood rules in the scheme.
The deduction rate depends on registration status:
| Subcontractor status | CIS deduction rate (2026/27) |
|---|---|
| Gross Payment Status (GPS) | 0% (paid in full) |
| CIS-registered | 20% of the labour element |
| Unregistered | 30% of the labour element |
Registration is free. The gap between 20% and 30% is the straightforward reason every subcontractor should be registered. After the tax year, the subcontractor files a Self Assessment return and reconciles the CIS deducted against the actual tax owed. Because neither the personal allowance nor any business expenses were factored in when the deductions were made, most registered subcontractors have overpaid and are due money back.
CIS vs PAYE: the full comparison
| Feature | CIS (self-employed subcontractor) | PAYE (employee) |
|---|---|---|
| Legal status | Self-employed sole trader (or limited company) | Employee |
| Who deducts? | Contractor deducts from the labour element of the invoice | Employer deducts through payroll on gross earnings |
| Deduction rate | 20% (registered) or 30% (unregistered) of labour; 0% with GPS | 20%/40%/45% income tax + 8%/2% employee NI, per tax code |
| Personal allowance treatment | Not factored in at source. Applied later via Self Assessment | Spread across the year through the tax code |
| Expenses | All allowable business expenses reduce taxable profit via Self Assessment | Only employment expenses qualifying under strict HMRC rules; no materials or general overheads |
| National Insurance | Class 4 (6% on profits £12,570 to £50,270; 2% above) + Class 2 (voluntary flat rate) | Employee Class 1 (8% on earnings £12,570 to £50,270; 2% above) |
| Employer NI | Not applicable (you are not an employee) | Employer pays 15% above £5,000 per year on your wages |
| Holiday pay | None (self-employed workers have no statutory entitlement) | Minimum 5.6 weeks statutory holiday pay per year |
| Sick pay | None (no statutory sick pay for the self-employed) | Statutory Sick Pay (£123.25/week for up to 28 weeks in 2026/27) |
| Pension | No auto-enrolment; must arrange your own | Auto-enrolled (minimum 8% total: 5% employee + 3% employer) |
| Refund position | Very common: overpayment likely every year because deduction ignores allowances and expenses | Uncommon unless tax code is wrong, multiple jobs, or untaxed income |
| Year-end filing | Self Assessment (mandatory) | Usually no return needed unless other income |
Employment status: who actually decides?
One of the most important and most frequently misunderstood points: employment status is not something the worker and contractor agree between themselves. It is determined by the reality of the working relationship, and HMRC can override any contractual label if the facts point to employment.
HMRC uses a multi-factor test drawn from case law. The three core questions are:
- Personal service. Can the worker send a substitute? A genuine, unfettered right to send someone else to do the work points away from employment. If the contractor can refuse any substitute, or if substitution has never happened and never could, the clause carries little weight.
- Control. Does the contractor control how the work is done, or just what the outcome should be? A worker directed on method, hours, location and approach day-to-day looks like an employee. A worker handed a specification and left to deliver it looks like a self-employed business.
- Mutuality of obligation. Is there an ongoing obligation on the contractor to offer work and on the worker to accept it? Genuine contracting ends when the project ends, with no standing expectation of further work.
No single factor is conclusive. HMRC and the courts look at the whole picture.
False self-employment: a live HMRC enforcement target
False self-employment (sometimes called bogus self-employment) is where a worker is placed on CIS when the working reality points to employment. Construction has historically been one of the most targeted sectors because the practice has been widespread. Common indicators include: working exclusively for one contractor for months or years with no other clients; having no financial risk (the worker is paid by the hour regardless of outcome); having no right to send a substitute; being told exactly how and when to carry out the work; and being integrated into the contractor's permanent workforce.
When HMRC finds false self-employment, the consequences reach both parties. The contractor can face unpaid employer National Insurance at 15% (2026/27) on all payments made, plus unpaid PAYE, plus interest and penalties. The worker may owe additional tax. The arrangement cannot simply be backdated to PAYE to avoid the liability.
If you are genuinely self-employed, CIS is correct. If the reality looks more like employment, a PAYE arrangement is both legally required and, in the long run, lower risk for everyone involved.
What the 20% CIS deduction actually covers (and what it misses)
This is the point that generates most confusion and most refunds. The 20% CIS deduction is applied to the labour element of each invoice across the year. It does not know:
- What your personal allowance is (£12,570 for 2026/27)
- What your allowable business expenses are
- Whether you have had any other income that has already used your personal allowance
- Whether you have made pension contributions that reduce your taxable income
It simply takes 20% off the labour element of every payment. If your labour income for the year is £40,000 and you have £8,000 of allowable expenses, your taxable profit is £32,000. Your personal allowance covers the first £12,570. You pay 20% income tax on £19,430, which is £3,886. But the contractor has already deducted 20% on £40,000 of labour, which is £8,000. The gap, £8,000 deducted versus £3,886 owed, is the refund. In this case, over £4,100.
This systematic overpayment is not an error or an anomaly. It is built into the design of CIS as an advance-payment scheme. The scheme does not adjust for allowances or expenses at source. That is what makes the Self Assessment refund an essentially annual event for most registered sole-trader subcontractors.
PAYE, by contrast, factors in the personal allowance throughout the year via the tax code, so the deduction is much closer to the actual liability at every pay point. Refunds under PAYE typically arise only from coding errors, mid-year job changes, or untaxed income sources.
Take-home comparison at a realistic 2026/27 day rate
The worked example below uses a plumber working 200 days a year at £200 per day (£40,000 annual labour turnover). All figures are 2026/27 using HP-locked rates. The CIS sole-trader column assumes £5,000 of allowable expenses (tools, mileage at 55p per mile from 6 April 2026, professional fees). The agency PAYE column reflects a typical construction labour agency arrangement.
| CIS sole trader (registered, 20%) | Agency PAYE | |
|---|---|---|
| Annual labour invoiced / gross wages | £40,000 | £40,000 |
| Materials (excluded from CIS base) | Separate, not deducted | n/a |
| CIS deducted at source (20% of £40,000 labour) | (£8,000) held by HMRC | n/a |
| Allowable business expenses | (£5,000) | Very limited |
| Taxable profit / taxable earnings | £35,000 | £40,000 |
| Personal allowance | (£12,570) | (£12,570) |
| Income subject to income tax | £22,430 | £27,430 |
| Income tax at 20% | £4,486 | £5,486 |
| National Insurance | Class 4: 6% on £22,430 = £1,346 | Employee Class 1: 8% on £27,430 = £2,194 |
| Total tax and NI owed | £5,832 | £7,680 |
| CIS already deducted at source | £8,000 | n/a |
| CIS refund due (overpaid at source) | £2,168 | n/a |
| Net take-home (gross minus total tax/NI) | £34,168 | £32,320 |
A few important caveats on this comparison. The CIS sole-trader figure depends on actually claiming the refund via Self Assessment. If the refund is not claimed, that £2,168 sits with HMRC indefinitely. The PAYE figure does not include any employer pension contribution, which would represent additional value not in the net wage. And the PAYE worker receives statutory holiday pay, statutory sick pay, and employer pension contributions that have a real monetary value the CIS comparison does not capture.
The point of the comparison is not to declare one system universally better. It is to show that the CIS deduction mechanism systematically withholds more than the subcontractor actually owes, and that reclaiming it through Self Assessment is the mechanism by which the position is corrected. Most registered subcontractors are owed money back every year. If you have been on CIS for a year or more and have not filed a Self Assessment return, the likelihood is that HMRC holds money that belongs to you. Our CIS refund service handles the claim and, more importantly, puts you on the right compliance footing going forward.
Agency PAYE vs CIS sole trader: the switching question
Many subcontractors start on agency PAYE and later consider moving to CIS, or find they are already on CIS but are unsure whether they should be. The switching decision has several dimensions.
Moving from agency PAYE to CIS sole trader
The financial case for moving is often real (as the table above illustrates), but it requires genuine self-employment. Before moving, ask honestly:
- Will you work for more than one contractor, or effectively for one agency's clients continuously?
- Can you genuinely send a substitute if you are unavailable?
- Do you carry your own tools and take financial risk on the outcome?
- Are you ready to handle Self Assessment returns, keep records, and manage the cash-flow gap between invoicing and receiving the year-end refund?
If those boxes are honestly ticked, moving to CIS sole trader is a legitimate and often financially sensible step. If they are not, the PAYE arrangement is both legally correct and administratively simpler.
Staying on CIS when the reality is employment
The risk of remaining on CIS when the working relationship looks like employment is that HMRC can reclassify it retrospectively. In a construction payroll investigation, HMRC will look at timesheets, site access records, who provided tools, and whether the worker had any other clients during the relevant period. The investigation period can extend several years. The financial exposure for the contractor, unpaid PAYE, employer National Insurance at 15% and penalties, can be substantial. Workers can also face additional tax and NI bills.
When a limited company becomes relevant
For subcontractors with consistently high turnover, a limited company structure allows CIS deductions suffered to be offset in real time against PAYE liabilities rather than waiting until after the tax year via Self Assessment. This is a genuine cash-flow advantage for higher earners. The structure also brings different compliance obligations. Our guide to CIS: sole trader or limited company covers when the switch makes financial sense and what the transition involves.
The refund is the entry point, not the destination
The overpayment built into CIS is real and reclaiming it matters. The typical registered CIS subcontractor receives a refund of £2,000 to £3,000 a year (industry figures, not a guarantee for any individual). That money is yours and should be claimed.
But the refund claim is the beginning of a compliant tax position, not the end of it. A Self Assessment return that only looks at CIS deductions, without reviewing allowable expenses, pension contributions, or the structure question, will often leave money on the table or, worse, create compliance problems down the line. The most useful thing most CIS subcontractors can do is get the refund claimed, get the expenses right, and put a structure in place that handles the filing annually so they are never more than one tax year behind.
To compare the two on your own numbers, use our CIS vs PAYE comparison calculator. It models take-home pay both ways with 2026/27 rates, including the NI difference most people miss.
If you have been on CIS for a year or more and have not filed, or if you are on PAYE and wondering whether a move to CIS makes sense for your situation, speak to us about a CIS refund and compliance review. We work exclusively in construction, so the CIS mechanics are not a sideline.