Construction Cost Inflation: How Contractors Can Protect Margins When Materials And Payroll Costs Rise

UK construction cost inflation is still running ahead of headline inflation in several key areas. The BCIS General Building Cost Index, which combines labour, plant and materials, rose by 3.8% in the 12 months to March 2026, while UK CPI inflation was 3.3% in March before easing to 2.8% in April. Material prices for All Work rose by 2.6% in the 12 months to March 2026, but the average hides much sharper category-level movements. Gravel, sand, clays and kaolin rose by 8.4%. Fabricated structural steel rose by 8.2%. Concrete reinforcing bars fell by 7.1%.

Labour remains one of the more difficult pressures to manage. The BCIS Labour Cost Index rose by 7.1% year on year in Q2 2025, and labour costs are forecast to keep rising over the next few years. If you are a contractor working on fixed-price contracts agreed six or 12 months ago, your margin may already be being eaten by costs you did not price in.

This article is for SME contractors, sub-contractors, principal contractors and developers operating across the UK and Ireland. It walks through where inflation is showing up, what is driving it, the practical levers that work, and the tax and compliance changes from April 2026 that have made the picture sharper.

Where construction inflation actually sits in 2026

The construction market is dealing with a difficult combination: weak demand in some areas and stubborn costs in others. ONS data showed that total construction output grew by 0.4% in Q1 2026 compared with Q4 2025, but this was driven by repair and maintenance, while new work fell by 1.9%. That matters because many contractors are still competing hard for new work while input costs remain elevated.

DBT data also shows the legacy of the post-pandemic cost shock has not disappeared. The All Work materials index remains far above its 2019 level, even though the rate of annual increase has slowed. BCIS forecasts building costs to rise by around 14% over the five years from Q1 2026 to Q1 2031, with tender prices forecast to rise by around 15% over the same period.

The wider rate environment makes this worse. The Bank of England held Bank Rate at 3.75% on 30 April 2026, and the European Central Bank held its deposit facility rate at 2.00% on the same day. For interest-sensitive sectors such as residential construction, financing conditions remain restrictive. Our piece on interest rates, inflation, and SME cash flow reforecasting covers the underlying rate position for any business that needs to refresh its forecast.

Materials: where the real divergence sits

The aggregate materials index hides large category-level moves. The picture looks like this for the 12 months to March 2026, based on DBT data reported by BCIS:

Two practical points come out of the table. The first is that on any project where groundworks, aggregates or structural steel are a significant proportion of the cost base, your input cost rises may be running materially above the headline construction materials index. The second is that the divergence between fabricated structural steel and reinforcing bars shows how category-specific these moves are. Treating “steel” as a single line item in your estimating model is too crude.

Energy remains one of the bigger underlying drivers. Cement, brick, steel and glass production are energy-intensive, so energy price movements can feed through into materials with a lag. For builders, joinery contractors and refurbishment specialists, our companion piece on common mistakes businesses make when claiming R&D tax relief is worth a separate read, because innovation in materials selection, groundworks methodology and sustainability is often quietly funded out of margin without anyone realising it could potentially be claimed as R&D.

Labour is the harder problem

Labour is harder to substitute than materials. The BCIS Labour Cost Index rose by 7.1% year on year in Q2 2025, and BCIS forecasts labour costs to keep rising over the medium term.

The drivers are well documented:

• Skills shortages remain acute in specialist trades, including MEP, façade work, fire protection, high-voltage electrical and retrofit skills.
• The Joint Industry Board electrical contracting agreement increased graded operative rates by 3.95% from January 2026, with further increases of 4.6% from January 2027 and 4.85% from January 2028.
• The National Living Wage increased to £12.71 per hour from 1 April 2026, a 4.1% rise for workers aged 21 and over, with larger percentage increases for some younger workers.
• Employer National Insurance changes from April 2025 increased the cost of PAYE employees.
• Skilled trades migration remains constrained by the UK points-based immigration system.

The bigger structural issue is that experienced trades are reaching retirement faster than apprenticeships are replacing them. This is a multi-year labour shortage, not a short-term spike. Our piece on salary sacrifice pension changes and our companion HMRC PAYE issues cover recent payroll changes that affect construction employers.

The CIS regime gets meaningfully tougher from April 2026

The April 2026 changes to the Construction Industry Scheme have shifted the compliance bar for contractors and increased the cost of getting it wrong.

The substantive changes are:

• Contractors must now file a CIS monthly return, including a nil return where no subcontractor has been paid, unless they make an inactivity request.
• An inactivity request can usually last for up to six months and can be renewed where the conditions are met.
• The full CIS late filing penalty regime applies. A late return triggers a £100 fixed penalty, then £200 after two months, with tax-geared penalties at six and 12 months.
• HMRC can immediately remove Gross Payment Status where a business knew, or should have known, that a payment was connected with fraud.
• HMRC can assess the related tax loss and charge a penalty of up to 30%, which can apply to the business or its officers.
• The wait to reapply for Gross Payment Status after losing it for fraud-related reasons has been extended to five years.
• Payments to local authorities and certain public bodies fall outside CIS from 6 April 2026, formalising previous concessionary treatment.

The “knew or should have known” test is the part most contractors are underestimating. It gives HMRC scope to look not just at what you actually knew, but what a reasonable contractor should have identified from the facts available.

Practically, this means:

• Verifying every new subcontractor properly and retaining evidence of verification
• Reviewing ongoing engagements rather than relying on the original verification indefinitely
• Building credit checks, trade references and tax compliance checks into your onboarding process
• Keeping clear records of what you checked, when you checked it and who approved the engagement

Our pieces on red flags of financial fraud in SMEs and how forensic accounting helps in fraud investigations cover the patterns that show up in supply-chain fraud cases. The evidential standard now expected of contractors is moving closer to the kind of forensic-grade work forensic accountants UK firms do for solicitors and insolvency practitioners.

What this does to your margin on fixed-price contracts

A contractor signing a £1.5m fixed-price contract in late 2025, with completion by Q4 2026, faces a clear margin problem.

If labour costs rise 7% over the contract life on a £450,000 labour element, that is £31,500 of margin gone. If materials rise 3% on a £600,000 materials element, that is another £18,000. Even before allowing for specific category moves like aggregates or structural steel, you have lost roughly £50,000 of margin on a contract priced at, say, £150,000 net profit. That is around one-third of the expected return.

If the contract has a typical 5% retention and stage payment terms, the cash position is worse again because the contractor funds working capital throughout the contract at borrowing rates well above pre-2022 levels.

This is the situation many UK contractors are now in. Some have priced cautiously enough to absorb it. Many have not.

Pricing levers that actually work

The practical contractual response is straightforward, but it requires conversations clients do not always like. The levers used by contractors protecting margin include:

• Price adjustment clauses tied to published indices, such as BCIS or DBT materials indices
• Quarterly material cost reviews
• Shorter fixed-price windows, such as 90 days rather than 12 months
• Provisional sums for high-volatility items such as aggregates, structural steel and energy-intensive materials
• Day-rate or cost-plus arrangements for time and materials work
• Pass-through clauses for statutory cost increases, including National Insurance, National Minimum Wage and Apprenticeship Levy changes

The barrier is rarely contractual sophistication. It is the willingness to walk away from contracts where the client refuses to share risk. The contractors who have walked away from loss-making risk over the last 18 months have generally done better than those who have accepted margin erosion for the sake of turnover.

For more on the wider commercial conversation, our pieces on how tax accountants help small businesses, how management accounts help SME owners and the key financial KPIs every SME owner should be monitoring monthly cover the underlying habits that make a sharper commercial position possible.

Cost levers contractors are actually using

On the cost side, the levers that have moved the needle for contractors managing through the current cycle include:

• Consolidating procurement to fewer, better-managed suppliers
• Pre-buying for known projects where storage and cash allow
• Bringing more direct labour in-house where the work profile supports it
• Investing in estimating and planning so contract pricing reflects actual delivery cost, not last year’s assumptions
• Reviewing plant ownership versus hire
• Using modular or off-site construction where the project profile allows
• Reviewing site energy costs, including cabin power, lighting and plant fuel

With interest rates still elevated and capital allowances changing, the lease versus buy calculation should be revisited. The main pool writing-down allowance rate reduced from 18% to 14% from 1 April 2026 for Corporation Tax purposes, although a new 40% first-year allowance for qualifying main-rate plant and machinery expenditure applies from 1 January 2026 where the conditions are met.

Our piece on the business owner’s guide to capital allowances covers the recent main rate change in detail. Our piece on switching to cloud accounting for SMEs covers the systems side of getting cost information visible in time to act on it.

The cash flow side

Construction has always been a high-working-capital business. The recent rate environment has made that harder to fund.

The areas worth tightening are:

• Retentions. The default 5% retention, often released in two halves at practical completion and the end of the defects period, ties up significant cash. Where possible, negotiate retention bonds or alternative security.
• Stage payments and applications for payment. Monthly valuations, prompt submissions and follow-up on overdue applications are worth a meaningful margin point on their own.
• Subcontractor payment terms. Paying subcontractors faster than you are paid is a recipe for cash strain. Aligning terms protects working capital.
• VAT cash flow. The construction domestic reverse charge has been in place since March 2021 and continues to affect cash timing for affected work.
• Corporation Tax timing. Section 455 director loan positions, dividend tax changes and capital allowance changes all affect tax cash flow. Our piece on director loans after April 2026 covers the Section 455 changes specifically.
• Late filing penalties. CIS, PAYE, VAT and Corporation Tax all carry penalty regimes that can turn a cash problem into a compliance problem.

For the broader cash flow conversation, our piece on how recovery accountants help improve cash flow sets out the pattern of where pressure builds, and our companion piece on how to prepare your business for sale is worth reading for any contractor thinking longer term.

Reliefs construction businesses often miss

Tax reliefs do not solve a margin problem. They can, however, create useful breathing space while operational changes take effect.

The reliefs that construction businesses often under-claim include:

• R&D tax relief. Under the UK merged scheme for periods beginning on or after 1 April 2024, qualifying activity can include new construction methodologies, novel ground engineering solutions, sustainability and retrofit innovation, and digital twin or BIM development. Our pieces on what qualifies for R&D tax credits in the UK and Ireland and the companion R&D piece cover the qualifying criteria.
• Capital allowances on plant, machinery, vehicles and integral features in buildings. Full expensing, the Annual Investment Allowance and the new 40% first-year allowance can still be valuable where the conditions are met.
• Land remediation relief, particularly where you are buying contaminated or brownfield sites. Our piece on land remediation relief explained covers who qualifies.
• Patent Box, if you hold patents on materials, processes or equipment. It can reduce the effective UK Corporation Tax rate on qualifying profits to 10%.
• Employment Allowance, where eligible, on employer National Insurance.

Specialist reviews often identify reliefs that have been missed because the finance team was focused on delivery rather than tax optimisation. Our specialist tax service page covers the broader range.

Cross-border considerations

If you operate across the UK to Ireland border, the construction tax position is different in each jurisdiction.

In the Republic of Ireland, the equivalent of CIS is the Relevant Contracts Tax regime, administered by Revenue. It is similar in purpose but different in mechanics. Irish contractors deduct RCT from subcontractors at 0%, 20% or 35% depending on the subcontractor’s status, and operate through the eRCT online system rather than UK CIS monthly returns.

VAT on construction services in Ireland also follows different rules, including reverse charge treatment in certain principal contractor situations. For SCC clients operating on both sides of the border, the same project can involve CIS in Northern Ireland, RCT in the Republic and different VAT treatment depending on the supply chain. Currency exposure on euro-priced materials or sterling-priced labour adds another layer.

This is where good Cross-border tax accounting earns its keep. Our pieces on VAT compliance for businesses operating across the UK to Ireland border, cross-border payroll and setting up a company in both the UK and Ireland cover the wider operational picture.

When margin pressure becomes a recovery problem

Most contractors will get through the current cycle. Some will not. The transition point from “tight” to “in trouble” tends to look the same.

The earlier you engage, the more options you have. Our recovery and restructuring team works regularly with construction businesses at every point along this curve, from early margin pressure conversations through to formal restructuring or insolvency where necessary. Our pieces on what an insolvency accountant does in business distress cases, what happens to creditors during company insolvency and what a forensic accountant does and when you need one cover the territory where this work sits.

The construction sector tends to feature heavily in UK insolvency statistics in every cycle. The pattern is predictable. The escape route, where one exists, is early engagement before options become forced.

The wider 2026 picture for contractors

For any contractor running a year-end review, the recent and current changes worth pulling into the conversation include:

• Mandatory CIS nil returns and stricter penalties from 6 April 2026
• Stricter “knew or should have known” supply-chain fraud rules and a five-year Gross Payment Status reapplication bar in fraud cases
• Local authority and specified public body payments outside CIS from 6 April 2026
• Capital allowances main pool writing-down allowance cut from 18% to 14% from 1 April 2026 for Corporation Tax purposes
• New 40% first-year allowance for qualifying main-rate plant and machinery expenditure from 1 January 2026
• Section 455 charge on overdrawn director loan accounts increased from 33.75% to 35.75% for loans made or benefits conferred on or after 6 April 2026
• Dividend ordinary and upper rates increased from 6 April 2026, while the additional dividend rate remains 39.35%
• Making Tax Digital for Income Tax now applies to sole traders and landlords with 2024/25 qualifying income above £50,000. Our pieces on Making Tax Digital and what UK and Irish businesses need to know and Making Tax Digital explained cover this in more depth.
• Corporation Tax fixed late filing penalties doubled for returns with a filing date on or after 1 April 2026
• Inheritance Tax 100% Business Property Relief and Agricultural Property Relief now subject to a combined £2.5 million allowance from 6 April 2026, with 50% relief applying above that level for qualifying assets

For owner-managed construction businesses, our piece on protecting the family business with a family charter is worth reading alongside the future of financial planning, particularly if succession is on the horizon. For contractors actively in or anticipating a sale, due diligence and its importance in business and the indispensable role of chartered accountants in mergers and acquisitions cover the data-quality side that makes a transaction smoother. For broader audit conversations that often come up at this stage, what to expect during an external audit and how a quality external audit strengthens trust with lenders and investors are useful.

FAQs

What is construction cost inflation in the UK right now?

The BCIS General Building Cost Index rose by 3.8% in the 12 months to March 2026. DBT construction material prices for All Work rose by 2.6% over the same period, with category-level moves ranging from +8.4% for gravel, sand, clays and kaolin to -7.1% for concrete reinforcing bars. The BCIS Labour Cost Index rose by 7.1% year on year in Q2 2025.

Why are building material prices still rising in 2026?

Energy costs, labour costs, supply-chain disruption and category-specific demand pressures are all contributing. Energy-intensive products such as cement, steel, bricks and glass are particularly exposed to movements in gas, electricity and fuel prices. At the same time, the post-pandemic reset in materials prices has not fully unwound.

What changes from April 2026 affect Construction Industry Scheme compliance?

From 6 April 2026, contractors must file monthly CIS returns, including nil returns unless an inactivity request is in place. HMRC can immediately remove Gross Payment Status where a business knew, or should have known, that a payment was connected with fraud. HMRC can also assess related tax loss and charge penalties of up to 30%. The reapplication period for Gross Payment Status in relevant fraud cases is five years.

How can contractors protect margins on fixed-price contracts?

The most effective levers are price adjustment clauses tied to published indices, shorter fixed-price windows, provisional sums for volatile material categories, and pass-through clauses for statutory cost increases. The harder discipline is walking away from contracts where the client will not share inflation risk.

Can construction businesses claim R&D tax relief?

Yes, where the work meets the R&D criteria. Qualifying activity may include new construction methodologies, novel ground engineering solutions, sustainability and retrofit innovation, and digital twin or BIM development. The merged R&D expenditure credit scheme applies for accounting periods beginning on or after 1 April 2024.

What is the equivalent of CIS in Ireland?

The Republic of Ireland operates the Relevant Contracts Tax regime, administered by Revenue. It is similar in purpose to CIS but uses different rates, namely 0%, 20% or 35%, and operates through the eRCT online system. Cross-border contractors operating on both sides of the border can be exposed to both regimes simultaneously.

When should a contractor speak to a recovery specialist?

When margin pressure starts showing in the management accounts, not when the overdraft hits the limit. The warning signs are usually visible months before things become forced. Engaging early is the difference between a manageable restructuring and a more constrained outcome.

Get the right support in place

If your construction business is feeling the pressure of rising costs, tightening compliance and shrinking margins, the next step is a hard look at the numbers with someone who knows the sector. As chartered accountants Northern Ireland, the wider UK and Ireland construction businesses rely on, our team works with main contractors, subcontractors, M&E specialists, civils contractors and developers on the operational, tax and recovery sides of the same picture.

Our SME business solutions team handles the management accounting and cash flow side, our tax compliance and specialist tax teams pick up the CIS, R&D, capital allowances and land remediation work, our digital bookkeeping team gets the underlying records clean, our corporate finance team supports funding conversations and transactions, and our external audit and internal audit teams handle the assurance work.

Get in touch with the SCC team for a margin and cash flow review tailored to a construction business operating in the current environment.