Many construction business owners know the feeling: the VAT quarter ends, the accountant sends the figure, and suddenly a large HMRC bill appears just as the business is juggling wages, suppliers, and retentions. It’s stressful, unpredictable, and completely avoidable with the right system.
This guide explains the best way to set aside money for VAT and tax — in a way that protects cashflow, stabilises your business, and improves margins. It is written specifically for UK construction companies and informed by the work we do daily at Thomas Emlyn Ltd through our Virtual Finance Office and Virtual Finance Director services.
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What’s the simplest way to set aside money for VAT?
Create a ring-fenced VAT account and move money into it every time you receive payment. Use a fixed percentage based on your VAT scheme, or calculate the exact VAT element from each invoice. This prevents accidental spending and ensures the VAT liability is always funded when the quarterly return is due.
Why this works (and why so many firms don’t do it)
Most construction firms “wait for the quarter”, then scramble. But VAT is never your money — it’s a flow-through item. Using it to prop up weekly cashflow creates instability and reduces margins because:
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Funds needed for materials or labour get squeezed.
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Suppliers might be delayed.
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Directors end up using personal cash or loans.
A dedicated VAT account solves this instantly.
Example: A contractor turning over £2.4m/year
A client we worked with (London-based, labour & materials) used to face £70k–£90k VAT bills each quarter — with no system to prepare. By moving the VAT element of every receipt into a ring-fenced account:
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Their cashflow stabilised within one quarter.
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The “VAT bill panic cycle” ended.
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They built a £120k buffer within six months.
This is typical for construction because payment flows are uneven and margins are tight.
How do I calculate how much to set aside each week or month?
Use either a percentage method (quick) or a real-time VAT calculation (accurate). Most firms set aside 16–22% of VAT-inclusive turnover. For CIS-heavy labour-only contractors, a lower percentage may be appropriate. Pair this with a rolling 12-month cashflow forecast for visibility.
Option 1: The Percentage Method
Good for: firms wanting a simple, automated system.
Typical VAT set-aside ranges by business type:
| Construction Business Type | Typical Set-Aside % | Notes |
|---|---|---|
| Labour & materials contractor | 16–20% | Higher if VAT on outputs exceeds inputs. |
| Labour-only subcontractor | 12–15% | Lower input VAT offsets the output VAT. |
| Specialist contractor | 15–18% | Depends on material-to-labour ratio. |
| Design & build | 18–22% | Variability in subcontractor mix. |
This method works well if turnover is consistent.
Option 2: The Real-Time VAT Calculation
Good for: businesses with fluctuating project values or significant retentions.
Two approaches:
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Automate via Xero/QuickBooks rules.
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Export invoices weekly and calculate VAT movement.
This gives a more precise figure — especially for businesses with large supplier VAT reclaim.
Option 3: Use the HMRC VAT Annual Accounting Scheme
Some firms benefit from paying VAT in monthly instalments.
Pros: predictable payments, less cash shock.
Cons: not suitable for businesses with rapidly changing turnover.
What about Corporation Tax — how do I set aside money for that?
Set aside a percentage of profit every month, not turnover. Most construction companies use 19%–25% depending on profitability and dividends. Use management accounts to track profit monthly, not annually. Without monthly accounts, any tax set-aside becomes guesswork and often leads to end-of-year surprises.
Why tax planning in construction is unique
Construction firms face inconsistent profit recognition due to:
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Retentions
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Stage payments
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Over/underbilling
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WIP and accruals
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CIS deductions
If you wait for year-end accounts, you will always be behind.
Example: £3m turnover specialist contractor
A Midlands firm had profitable projects but unpredictable year-end tax bills. After implementing a monthly profit tracker and setting aside 21% of projected profits:
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No more surprise Corporation Tax bills
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Directors confidently drew more predictable dividends
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WIP reporting improved margins by ~4% over 12 months
This is the power of real-time financial data — a core part of Thomas Emlyn Ltd’s Virtual Finance Office.
How does CIS affect the money I need to set aside?
If you suffer CIS deductions, set aside less for Corporation Tax because the CIS credits reduce your tax bill. If you pay CIS to subcontractors, ensure monthly CIS returns are correct — errors slow refunds and damage cashflow planning.
CIS planning tips
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Maintain up-to-date verification checks.
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Reconcile CIS suffered monthly — not once per year.
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Check subcontractor UTRs early to avoid delays.
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Use a CIS ledger to track running deductions.
Incorrect CIS is one of the biggest causes of HMRC disputes in construction.
How can I avoid VAT and tax becoming a cashflow problem?
Use ring-fenced accounts, accurate monthly financials, and a rolling cashflow forecast. Combine VAT, CIS, and Corporation Tax planning into one integrated dashboard so you always know your liabilities 6–12 months ahead. This turns cashflow from reactive to proactive.
The system every construction company should use
A best-practice model includes:
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Dedicated VAT account
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Dedicated Tax (Corp Tax + Personal Tax) account
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12-month cashflow forecast
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Monthly management accounts
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Weekly bank reconciliations
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Job-costing reports that match project reality
This is the system construction businesses get through the Thomas Emlyn Ltd Virtual Finance Office — giving owners total clarity on margins and cashflow.
Why do some firms still struggle even when they set money aside?
Because the numbers they’re using are wrong. If margins aren’t accurate, the VAT and tax set-aside becomes inaccurate too. Clear job costing, up-to-date bookkeeping, and monthly reporting are the foundation of reliable tax planning.
Where things often go wrong
Common errors we fix include:
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Allocating labour to the wrong project
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Not capturing material costs correctly
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Underbilling work done (especially on long-term projects)
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Forgetting retentions
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Overly optimistic director drawings
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Using last year’s profit to predict this year’s tax
A strong financial system protects the business from itself.
FAQs: Setting Aside VAT & Tax for Construction Companies
1. Should I use one bank account or multiple accounts for tax?
Most firms benefit from two ring-fenced accounts: one for VAT, one for Corporation Tax and personal tax. This provides clearer visibility. Some firms also use a “buffer” account to build cash reserves equivalent to 1–2 months of operating costs.
2. How often should I transfer money to the VAT or tax account?
Weekly is ideal for cash-heavy construction firms. Monthly is acceptable for predictable, contract-based businesses. The key is consistency — set it up as a standing instruction so it happens automatically.
3. What if cashflow is too tight to set aside money?
This usually indicates one of three issues: underpricing, inaccurate margins, or slow debtor collection. Many businesses discover a hidden 5–12% margin loss once we implement proper job costing and WIP tracking. Fixing margins often solves the tax problem.
4. Should I switch to the VAT Cash Accounting Scheme?
Good for firms with slow-paying customers — you only pay VAT when you’re paid. Less useful for firms with large input VAT reclaim. A short review with your accountant can confirm the best option.
5. What’s the best first step if I want to get this under control?
Start with a 12-month cashflow and margin review. Thomas Emlyn Ltd performs this for construction companies to identify the right VAT/tax set-aside method and build a clear financial system that supports sustainable growth.
Thomas Emlyn Ltd
Stronger Margins – Healthier Cashflow – Sustainable Growth
