IR35 – Deemed Payment and the treatment of expenses

The main purpose of IR35 is to remove the tax advantages of extracting dividends from limited companies, where work carried out by the company’s director is more akin to an ’employee’ rather than a ‘self-employed’ person.

The intention of the IR35 rules is to tax most of the company’s income as if it were a standard salary.

Please scroll down to read important information about the ‘Off Payroll’ rules, which radically reduce the opportunity for contractors to claim the 5% allowance.

Expenses under IR35 – the 5% Allowance

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.

You will also be able to claim other contractor 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:

  • Travelling purely for business purposes.
  • Subsistence when working away on business (e.g. accommodation, meals).
  • Professional Indemnity and other types of business insurance
  • Executive or personal pension payments.

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

Off-payroll 5% allowance exclusion

Importantly, if you work for a public sector body, since April 2017, you can no longer claim the 5% allowance – due to the off-payroll rules.

This exclusion was extended to all but ‘small company’ private sector clients from April 2021 onwards.

So, from April 2021 onwards, if your contract work is caught by the IR35 rules, you can only claim the 5% allowance if you work for a ‘small company’ end client or if the client is based outside the UK.

You can read more about the definition of a ‘small company’ here.

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 taxman 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.

Visit this HMRC guidance for more in-depth information on calculating the deemed payment.

You must consult your accountant before relying on any information contained within this article.

Partner Contractor Accountants

Last updated: 12th December 2023