Construction invoice finance: CIS and retentions

Why construction is harder to fund than other sectors

Construction invoice finance is not a straightforward extension of standard invoice finance. Construction work is usually billed through contract based processes rather than simple invoices for goods delivered. A contractor or subcontractor may submit an application for payment, which is then certified or valued before an invoice becomes due. The amount requested can differ from the amount certified, and the final sum may be reduced by set off, retention or disputed items. Funders that advance against standard invoices expect a clear debtor, a defined invoice value and a predictable payment date. In construction, those features are often absent. The underlying contract, the valuation process and the payment framework all affect what is owed and when. Applications for payment are commonly excluded from standard invoice finance because they are not final invoices. Retentions are often excluded as well because release depends on completion and a defects period. These features help explain why many funders treat construction as a specialist sector rather than a routine invoice finance market. The result is that a funder may need to assess the contract before it can value the receivable.

Contract based billing also brings set off and dispute risk. A payer may withhold sums for delay, defects, contra charges or incomplete work. The Construction Act provides payment notice and pay-less notice rules, but those rules do not remove commercial disagreement. A funder assessing a construction receivable needs to understand the contract, the certified amount, the notice position and any retention or set off. Standard invoice finance facilities may not be designed for that level of assessment. They may also exclude applications for payment and retentions from the eligible receivables. As a result, a construction business can have substantial work in progress and certified sums due while the amount that a standard facility will fund remains limited. Specialist construction invoice finance addresses those features by focusing on certified applications and contract terms. The sector is harder to fund because the cash conversion cycle depends on contractual milestones, notices and valuations rather than a simple invoice and payment date. That assessment can take time and may require documents beyond the invoice itself. The contract and the notice trail are central to that review.

CIS deductions and their effect on cash flow

Under the Construction Industry Scheme, contractors deduct tax from payments to subcontractors. The deduction is 20% for registered subcontractors, 30% for unregistered subcontractors and 0% for subcontractors with gross payment status. Those deductions affect the cash that reaches a subcontractor, even where the invoiced or certified work is otherwise payable. A funder advancing against a construction receivable therefore has to consider whether the amount to be paid will be reduced by CIS. If the invoice is funded at its gross value, the cash received from the debtor may be lower than the amount advanced plus charges. For that reason, construction invoice finance is often structured around the net amount expected after CIS. The 20% and 30% rates apply to the relevant payments, while gross payment status removes the deduction at source. The tax position of the subcontractor also matters because CIS deductions are not necessarily a final cost. A facility sized on gross invoice values may therefore face a shortfall when the payer deducts CIS. The net amount is the relevant cash expectation for the funder in practice. That point is central.

For limited companies, CIS deductions can be offset against PAYE and other payroll liabilities in the normal way. For sole traders, the position can involve a tax refund or a credit through the tax return process. These mechanisms affect cash flow timing rather than the underlying value of the work. A funder may still focus on the net receivable because that is the amount the contractor is expected to pay. Construction invoice finance can advance cash against certified or invoiced work, but CIS deductions, retentions and stage payments make it harder to fund than standard invoices. The practical effect is that a subcontractor may carry a timing gap between the gross value of work done and the net cash received. Funding against net amounts can reduce that gap, but it also means the facility is sized to the cash that the contract is expected to produce. Gross payment status can improve the cash position because no CIS deduction is made at source. The contract and the payer still require detailed assessment before the net cash position can be fully understood.

The Construction Act payment framework

The Housing Grants, Construction and Regeneration Act 1996, Part II, sets the statutory payment framework for construction contracts in the United Kingdom. The framework was amended in 2009. It requires construction contracts to provide for payment notices, pay-less notices and a final date for payment. A payment notice states the amount considered due. A pay-less notice explains any amount that the payer intends to withhold and the basis for that withholding. The final date for payment determines when the notified sum becomes payable. These rules give the parties a structure for payment and withholding, but they depend on notices being given within the contractual and statutory timescales. The framework also provides a route to adjudication, which allows a dispute to be referred to an adjudicator for a decision within a short period. Adjudication is a temporary decision-making process rather than a final determination of all rights. The statutory framework applies to construction contracts that fall within its scope. It sets defined payment events and a route for resolving payment disputes. Those features matter directly to both funders and payers alike.

The Construction Act also restricts pay-when-paid clauses. Such clauses make payment by one party conditional on payment from another party further up the chain. They are generally prohibited, except in limited circumstances involving upstream insolvency. That restriction matters for cash flow because a subcontractor can rely on the contractual payment framework rather than an open-ended wait for a higher tier to be paid. The payment notice and pay-less notice rules, the final date for payment and the adjudication route all affect the quality of a construction receivable. A funder reviewing a certified application will consider whether notices have been given and whether the final date for payment has passed. The statutory framework does not guarantee payment, but it provides defined events and dates that can be assessed. Those features distinguish construction receivables from simple trade invoices and explain why specialist assessment is often required. A pay-when-paid clause may still operate in upstream insolvency situations where the statutory exception applies. The contract terms and the notice trail always still remain central to that assessment for a funder at the review stage.

Retentions and stage payments

Retentions are sums withheld from payments during a construction project. They are held as security for completion and for defects that appear during a defects period. A typical contractual arrangement allows part of each payment to be retained until practical completion, with a further part released after the defects period. The exact terms depend on the contract, and the amounts are not invented by a funder. Retentions affect cash flow because work that has been carried out and certified may not produce the full cash amount at the time of the application. A funder looking at a construction receivable may exclude retention amounts from the eligible value because release is deferred and conditional. The retention is not necessarily lost, but its timing and receipt depend on completion, snagging and defect issues. Standard invoice finance is not usually designed to advance against a sum that is not yet due and may be reduced or delayed. The contract may set different release points and different proportions for each stage. Those terms affect the timing of cash for the business overall in practice.

Stage payments and certified valuations also differ from simple invoicing. A construction contract may provide for payment by stages, milestones or periodic valuations. An application for payment is submitted, then certified or assessed by the payer or contract administrator. The certified amount may be less than the amount applied for. Stage payments can create a series of receivables, but each one depends on the contract and the valuation process. Funders often prefer certified applications because they provide evidence of the amount accepted as due. Applications for payment and retentions are often excluded from standard invoice finance. That exclusion reflects the conditional nature of the sums and the need to assess the contract, the certification and the payment notices. Specialist construction facilities may consider certified applications, but the treatment of retentions and uncertified stage payments remains a key difference from standard invoice finance. A certified valuation is not the same as a final invoice, and the payment notice may state a different sum. The funder then has to trace the notice and the certified amount in the full file for review.

VAT domestic reverse charge

The VAT domestic reverse charge applies to most construction services supplied between VAT-registered businesses since 1 March 2021. Under the reverse charge, the customer accounts for the VAT rather than the supplier charging VAT on the invoice. That changes the amount shown on the invoice and the cash flow associated with VAT. A construction invoice finance facility therefore needs to distinguish between the net value of the work and any VAT treatment. If the supplier does not charge VAT under the reverse charge, the invoice value funded is likely to reflect the net amount rather than a gross amount including VAT. The customer accounts for the VAT through its VAT return, subject to the normal rules. The reverse charge does not change the underlying construction work or the contract price, but it changes the invoice mechanics. Those mechanics can affect the amount that a funder is willing to advance against a receivable. The invoice may show a net charge with no VAT added by the supplier. That point matters directly to the funded value in a facility for construction work.

The domestic reverse charge interacts with CIS and with the payment framework. A certified application may be subject to CIS deductions, retention and reverse charge VAT treatment at the same time. A funder assessing the receivable has to identify the net cash amount expected from the payer. If VAT is not charged by the supplier, there is no VAT element in the invoice to finance. That can simplify the invoice value, but it also means the funded amount is based on the net construction charge. The reverse charge applies to most construction services between VAT-registered businesses, although the precise scope depends on the rules and the nature of the supply. For construction invoice finance, the key point is that the invoice value funded aligns with the amount the payer is expected to pay. The reverse charge is therefore part of the contract and invoice assessment rather than a separate funding product. It does not remove the need to review the contract and the parties. The VAT treatment is a factual point in the assessment of the receivable for funders here.

Late payment, adjudication and what to check

Late payment in construction can be addressed through contractual terms, statutory late payment protections and adjudication. The Late Payment Act framework can provide compensation where commercial debts are paid late, in addition to interest. The precise entitlement depends on the statute and the circumstances. Adjudication under the Construction Act provides a route to a decision on a payment dispute within a short period. It is not a final court process, but it can produce a decision that affects cash flow. A construction business reviewing its position may consider the contract terms, the payment notices, the pay-less notices and the final date for payment. It may also consider whether a dispute has arisen and whether adjudication is available. These are factual checks rather than a guarantee of recovery. The existence of a statutory route does not remove the need to comply with notice requirements and contractual timescales. The contract may set shorter or longer periods within the statutory limits. Those periods affect the date on which a sum becomes overdue and the point at which a dispute can be formally referred.

A neutral checklist for construction invoice finance can include the contract terms, the certified application, the payment notice, the pay-less notice, the final date for payment, CIS status, retention terms and VAT treatment. It can also include concentration limits, debtor credit quality and any personal guarantees. Personal guarantees may be requested by a funder as credit support, but their effect depends on the wording and the circumstances. The Late Payment Act compensation position and the adjudication route are relevant to recovery and cash flow timing. Funders may assess whether the receivable is a certified application rather than an uncertified application for payment. They may exclude retentions and disputed sums. The checklist is a neutral aid and does not replace legal or tax advice. It identifies the documents and facts that commonly affect whether a construction receivable can be funded and how much cash the facility may advance. The checklist is a prompt for fact finding rather than a substitute for due diligence. It can only be used alongside full legal and tax advice for the transaction in each individual case.

Frequently asked questions

What are the CIS deduction rates?

20% for registered subcontractors, 30% for unregistered, and 0% for those with gross payment status.

Can applications for payment be funded?

Some specialist construction funders fund certified applications; many standard factors exclude them.

Are retentions included in invoice finance?

Usually not; retentions are generally excluded until released.

Does VAT reverse charge affect invoice finance?

Yes, reverse-charge invoices carry no VAT for the customer to pay to the supplier, so the funded amount excludes VAT.

Are pay-when-paid clauses allowed in construction contracts?

Generally no; the Construction Act prohibits them except where an upstream party is insolvent.