The confederation had proposed the introduction of a system for handing out gross payment certificates based on VAT payments, which would have increased the number of contractors eligible for tax relief.
Gross payment certificates are granted to traders to compensate for the CIS deduction, which taxes £18 of every £100 spent by builders. To qualify for the certificate, contractors have to meet two requirements: they must show a clean taxpaying history and a turnover of £30,000 per trader.
Liz Bridge, head of taxation at the confederation, said that the current scheme made it too difficult for smaller business to become eligible for the tax deduction.
She said: "The difficulty is that many construction businesses are companies. And as it's a legal requirement to have two directors of a company, that works out at a £60,000 threshold."
According to the current system, sole traders who want to set up companies with, for instance, their wife or a member of their family, face a doubled turnover threshold of £60,000.
The confederation had proposed that the government measure not the size of turnover but whether contractors were VAT registered.
She said: "It's an indication of respectability – if you're an honest construction company you want to recover the VAT on your costs incurred and you are therefore joining the tax club."
Bridge claimed that the only sector to benefit from the government's rejection of the scheme was the black economy, in which sole traders could claim for the growth payment certificates because they had turnovers in excess of £30,000 but below £54,000 – the limit above which VAT must be paid.
She said: "The government likes the amount of tax that comes in under deduction from companies that have a clean taxpaying record but can't reach the threshold of £60,000. But they are penalising good, clean traders."
She added that the VAT proposal was supported by contractors large and small, the National Federation of Builders, the Federation of Master builders and the Federation of Small Businesses.