If your 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 (in a limited number of cases).
When calculating the IR35 deemed payment, income for each contract caught by the IR35 rules should be combined.
The 5% allowance should be deducted from this total figure at the end of each year, before calculating your tax and national insurance liabilities.
You are not required to demonstrate expenditure and can claim 5% regardless of your actual outlay for administrative costs.
If IR35 only applies to part of your contract work during the tax year, then the deemed payment will only apply to that proportion of your company’s turnover – and the 5% allowance will be applied in the same proportion.
What type of costs does the ‘allowance’ cover?
Some of the typical expenses you can expect to incur as a limited company owner include:
- Accountancy and legal fees.
- Training courses.
- Stationery, printing and postage costs.
- Other office costs.
- Computer equipment and software.
- Bank and finance charges.
Can you claim any additional expenses?
In addition to this 5% allowance, contractors caught by IR35 can still claim expenses under Section 336 of the Income Tax (Earnings and Pensions) Act 2003. When IR35 was implemented in 2000, these were known as Section 198 expenses.
- Professional indemnity insurance.
- Travel costs incurred solely for business purposes (subject to the “24 month rule“).
- Executive or personal pension payments.
- Subsistence when working away from home.
- Professional subscriptions.
Off-Payroll exclusion to the 5% allowance
In April 2017, new ‘off-payroll’ rules were introduced for individuals who undertake contracts for public sector organisations. If your assignment is deemed to fall within the IR35 rules, your limited company can’t claim the 5% allowance.
According to HMRC, the removal of the allowance:
…reflects the transfer of responsibility for making a decision about whether the rules apply and deducting and making the associated tax and NICs payments.
This exclusion was extended to all private sector organisations from April 2021 onwards, unless the client is deemed to be a ‘small company’.
So, from April 2021 onwards, unless your client is a ‘small company’ (as per the HMRC definition), if your contract is caught by IR35, then you will not be able to use the 5% allowance.
How is the allowance included in my limited company accounts?
Importantly, the 5% amount is only used when working out the deemed salary calculation.
When your accountant prepares your company’s annual accounts, only the true cost of any allowable expenses you have incurred during the year will be included.
You can find out more in HMRC’s IR35 guidance here (which includes information on how capital allowances and company cars are treated), and always ask your accountant if you have any questions about how the IR35 rules apply to you.
For ultimate peace of mind and defence in the event of an IR35 investigation, take out Qdos’ award-winning IR35 insurance – from just £99 per year. This covers up to £50,000 of professional representation and potential tax liabilities up to your chosen level of indemnity.