The primary purpose of IR35 is to eliminate the tax advantages of extracting dividends from limited companies where the work carried out by the director is more akin to that of an employee than that of a genuinely self-employed person.
Under IR35, if your contract is caught by the rules and your limited company is responsible for assessing IR35 status, most of your company’s income may need to be taxed as employment income.
Scroll down for important information on the Off-Payroll rules and how they affect eligibility for the 5% allowance.
Expenses under IR35 – the 5% allowance
If your contract falls within IR35 and your company is still responsible for status determination, you may be able to deduct a flat-rate 5% allowance from relevant contract income before calculating the deemed payment.
This allowance is designed to cover administrative expenses and does not require receipts or itemisation.
You can also claim certain other allowable expenses under tax law, such as business insurance or pension contributions. These must be incurred wholly, exclusively and necessarily for the purposes of your work, in line with Section 336 of the Income Tax (Earnings and Pensions) Act 2003.
Off-Payroll: when the 5% allowance no longer applies
Since April 2017 (public sector) and April 2021 (most private sector contracts), the Off-Payroll Working rules mean that the client – not your company – is responsible for assessing whether IR35 applies.
If your client is a medium or large organisation, and the contract is deemed inside IR35, you will usually be taxed via PAYE by the agency or client. In this case, the 5% allowance cannot be claimed.
The allowance is only available if your end client is a small private company under the Companies Act criteria, or if the client is based wholly overseas.
If IR35 applies and your company receives gross income for the engagement, you are required to calculate a ‘deemed payment’ at the end of the tax year. This ensures that the correct amount of PAYE and NIC has been paid on the income treated as employment earnings.
Typically, your accountant will carry out this calculation, which follows these steps:
Total all income your company received during the tax year for contracts caught by IR35.
Deduct 5% of this total – this is the flat-rate administrative allowance (if applicable).
Add the value of any benefits in kind you received that have not already been taxed.
Deduct any allowable business expenses under Section 336 (e.g. pension contributions, insurance).
Deduct any employer’s National Insurance contributions already paid by the company.
Deduct the salary you have already taken through PAYE during the year.
If there is any remaining amount, this is the ‘deemed payment’ and must be subject to PAYE and NIC before the end of the tax year.
Note that if your income is already taxed at source under the Off-Payroll rules, you will not need to perform this deemed payment calculation.
The rules around IR35 and the deemed payment calculation are complex and depend on your specific contract and client. If you are unsure how the rules apply to your situation, always seek advice from your accountant or a specialist tax adviser.
