Solicitor Gemma Smith, in our Commercial Property team, explains collateral warranties.
Did you know that being the beneficiary of a collateral warranty could make you subject to the Construction Industry Scheme legislation as if you were the contractor?
In a 2013 case of Parkwood Leisure Ltd v Laing O’Rourke Wales & West Ltd it was held that collateral warranties (a document intended to provide contractual remedies to those who are not party to the primary contract i.e. purchasers, funders and tenants) can amount to a construction contract in certain circumstances. This is more likely to be the case where the contractor agrees with the beneficiary that they will carry out the construction operations rather than where the works are already completed and the contractor is warranting a certain level of quality.
The Construction Industry Scheme (CIS) legislation applies to all payments made under a construction contract between a contractor and a subcontractor and was designed by HMRC to prevent tax avoidance in the building industry. The following may be considered a ‘contractor’ for the purpose of this legislation:
- property developers and builders
- businesses which are not in the construction industry but which have spent an average of £1 million+ on construction projects for the last three accounting periods
- some public bodies
A subcontractor is a person receiving payments under the construction contract and is under a duty to the contractor to carry out construction operations. This applies to self-employed subcontractors only and not to the subcontractor’s employees as these will be taxed through the PAYE system.
The CIS legislation requires the contractor to deduct tax at source on any payments it makes to the subcontractor. Obligations on the contractor will be as follows:
- to register as a contractor with HMRC
- verify the status of the subcontractor to HMRC
- keep records of gross amounts paid, costs of materials and amount of tax deducted
- make monthly returns relating to the payment of subcontractors to HMRC
The above obligations may fall upon a beneficiary of a collateral warranty where it amounts to a construction contract and if the CIS legislation applies (if there is a contractor and a subcontractor within the definitions set out in the CIS legislation).
In light of the above, if collateral warranties are required, it is best these be obtained when the lease is granted or when works have been completed and expressed this as a past state of affairs.
A buyer, tenant or funder, however, will often require warranties earlier. There is a school of thought which now suggests that this should be dealt with by reliance on the Contracts (rights of third parties) Act 1999 within the appointment of the contractor, making sure that the provisions of the Act are not excluded and that the intended beneficiary is identified in this document as a party who may benefit from the contractor’s obligations under the contract. This would avoid the CIS legislation but care would be need to be taken to ensure that the relevant third party could benefit from the contract.
For further information or legal advice, please contact law@blandy.co.uk or call 0118 951 6800.
This article is intended for the use of clients and other interested parties. The information contained in it is believed to be correct at the date of publication, but it is necessarily of a brief and general nature and should not be relied upon as a substitute for specific professional advice.
