IR35 - Deemed Payment and the Treatment of Expenses

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IR35 - Deemed Payment and the Treatment of Expenses

Published on May 6, 2006

The main point of IR35 is to remove the tax advantages of extracting dividends from limited companies (as no national insurance is paid on them). The intention of the IR35 rules is to tax most of the company's income as if it were a standard salary.

Expenses under IR35 - the 5% Allowance

If your IT contract work is caught by the IR35 rules, you will receive most of your income in the form of a 'deemed payment', net of a standard '5% allowance' to cover administrative expenses.

You will also be able to claim other expenses on top of the 5% allowance, such as insurance cover and pension contributions.

This expenses allowance is a flat rate deduction of 5% of the gross fees receivable for any relevant contracts and you do not need to provide receipts.

In addition to the standard 5% allowance, IT contractors caught by the rules can still claim standard "Section 198" expenses (section 198(1) of the Income & Corporation Taxes Act 1988), such as:

Traveling purely for business purposes.
Subsistence when working away on business (e.g. accommodation, meals).
Professional Indemnity and Business Insurance cover.
Executive or Personal Pension payments.

Section 198 expenses must be wholly, exclusively and necessarily incurred for the purposes of the office or employment.

The IR35 Deemed Payment Calculation

If you are caught by IR35, you should pay NIC's (National Insurance Contributions) and PAYE on all salary payments throughout the tax year. At the end of each tax year, you need to check that the total deductions made to the tax man are correct.

At the end of the tax year, you (or more likely, your accountant) will calculate how much money you can draw from the company - known as the "deemed payment".

To do this, you need to:

1) Calculate the total income received by your company over the tax year from any IT contract work which falls under the IR35 rules.

2) Deduct 5% from the total - you do not need to account for this amount.

3) Add any other benefits in kind received throughout the year, providing they have not already been taxed.

4) Deduct any allowable Section 198 expenses (see above).

5) Deduct the total amount of Employers NIC's paid during the year.

6) Deduct the total amount of salary drawn during the tax year.

7) The remaining total is known as a "deemed payment" - if this is greater than zero, you must pay further tax and NIC's on this final amount.