If your contract work is caught by the IR35 rules, and your limited company is responsible for determining IR35 status, you may be entitled to a flat 5% deduction to cover administrative expenses.
Importantly, however, this 5% allowance is only available in a limited set of circumstances.
Most contractors cannot use it following the introduction of the Off-Payroll Working rules in the public sector (2017) and most of the private sector (2021).
When does the 5% IR35 allowance apply?
You can only apply the allowance when your own company is still responsible for determining IR35 status. This is usually the case when:
You are working for a small private sector client, as defined by the Companies Act (see here), or
You are working for an overseas client with no UK presence
If your client is a public body or a medium or large private sector company, they are responsible for assessing IR35 status.
If they decide that your contract falls within IR35, your income will be taxed at source by the client or agency. In that case, you will not be able to apply the 5% allowance.
Summary: when the 5% allowance applies
Scenario
5% Allowance Available?
Public sector contract (since April 2017)
❌ No
Medium or large private sector client (since April 2021)
❌ No
Small private sector client (PSC determines IR35)
✅ Yes
Overseas client with no UK presence
✅ Yes
For confirmation, see HMRC’s own worked example: ESM8150.
How does the 5% allowance work?
At the end of the tax year, your accountant will calculate a deemed payment for all income caught by IR35. From the total, you can deduct a flat 5% allowance to cover general business running costs. This is done before tax and NIC are calculated.
You do not need to keep records to justify the 5% allowance. It is a fixed-rate deduction.
If IR35 applies to only part of your income, the 5% deduction is applied proportionally.
What does the allowance cover?
The allowance is designed to cover the typical costs associated with running a limited company. These include:
Accountancy and legal fees
Office costs and equipment
Stationery, printing and postage
Bank and finance charges
Software and training
You do not list these expenses separately when calculating your deemed payment. The 5% allowance covers them as a whole.
Can you claim any additional expenses?
If you are working inside IR35 but still paid via your limited company (not taxed at source), you can claim specific expenses under Section 336 of ITEPA 2003. These must be incurred wholly, exclusively and necessarily in the performance of your duties.
However, if your income is taxed at source under the Off-Payroll rules, you cannot claim travel, subsistence or similar costs, as these are treated as part of your gross pay.
How does it appear in your accounts?
The 5% allowance is used only for the IR35 deemed payment calculation. It does not appear as an expense in your limited company’s statutory accounts.
Your actual company accounts will include only genuine business expenses incurred during the year.
If you are unsure whether your client qualifies as a small company or how IR35 applies to your contracts, speak to a qualified accountant.
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