What is the cost of IR35 applying?
Many contractors concentrate more of their time in considering the positive aspects of their ‘hypothetical’ contract that will place them outside of IR35 and quite rightly too. However, for those freelancers that wish to insure against the risk of being caught by IR35 they need to have an idea of the level of PAYE tax and NIC that is at stake so as purchase the correct level of tax loss indemnity. There are numerous calculators that can be found on the internet that will give ball park numbers but for those that want a truly accurate assessment of what’s at stake then it is necessary to carry out the ‘deemed payment’ calculation.
When IR35 applies to a particular contract then all the fee income arising will be classified as salary subject to PAYE and NIC. This is known as the deemed payment and is calculated by following a number of steps. It is also necessary to include alongside the income any payments or benefits received by the worker, or their family, from third parties.
Allowable expenses
In calculating the deemed payment the following deductions are allowed:
- A flat 5% of the gross income to cover miscellaneous expenses such as overheads of the contractor’s PSC. This allows for the general expense of running a business, such as training costs and the cost of looking for contracts. There’s no restriction on the use of this allowance. You’re not required to justify this expenditure – the 5% deduction will be allowed in all cases.
- Expenses paid by the PSC which would have been deductible under employment income rules had the contractor incurred them personally, e.g travel expenses, professional subscriptions.
- Capital allowances where plant or machinery bought is necessary for the performance of the relevant work engagement duties. This means that relief will only be given if the duties of the engagement meant that the PSC had to provide the equipment in question. If the company purchases the equipment out of choice then no deduction is given.
- Employer pension contributions made to an approved scheme for the contractor’s benefit.
- Any employers Class 1 and Class 1A NIC paid during the year including the NIC due on the notional salary.
- Any salary paid in the year to the contractor.
- Any benefits-in-kind received by the contractor.
Illustration
Go On Ltd, owned by Mr and Mrs Doyle, receives £100,000 in respect of contracts that fall to be caught by IR35. Mr Doyle earns £40,000 of the company fees and Mrs Doyle £60,000. In addition the company receives a further £10,000 of income from other business activities unaffected by IR35. Accounts are prepared annually to 5th April and in the year ended 5th April 2015 the company incurs the following expenses:
| Mr Doyle £ | Mrs Doyle £ | |
|---|---|---|
| Salaries | 40,000 | 10,000 |
| Employers NIC | 4,422 | 282 |
| Pension contributions | 4,000 | 4,000 |
| Travel costs re contracts caught by IR35 | 2,000 | 3,000 |
In addition, the company has other business expenses totalling £20,000 which are allowable for corporation tax purposes.
Deemed payment
| Step | Mr Doyle (£) | Mrs Doyle (£) |
|---|---|---|
| Income from contracts | 40,000 | 60,000 |
| Less: 5% flat deduction | -2,000 | -3,000 |
| Income/benefits ex third parties | 0 | 0 |
| Total income | 38,000 | 57,000 |
| Less Expenses: | ||
| Travel | -2,000 | -3,000 |
| Capital allowances | 0 | 0 |
| Pension contributions | -4,000 | -4,000 |
| Employers NIC | -4,422 | -282 |
| Salary | -40,000 | -10,000 |
| Benefits-in-kind | 0 | 0 |
| Net income | 0 | 39,718 |
| Employers NIC on net income; £39,718 x 13.8%/113.8% | 0 | -4,816 |
| Deemed employment income payment | 0 | 34,902 |
Mrs Doyle’s employment income position 2014/15
| £ | |
|---|---|
| Salary received from the company | 10,000 |
| Deemed employment payment on 5th April 2015 | 34,902 44,902 |
| Employees NIC & PAYE tax due = | 11,717 |
Go On Ltd’s accounting and tax position
| £ | £ | |
|---|---|---|
| Turnover | 110,000 | |
| Less: | ||
| Salaries | 50,000 | |
| Employer’s NIC | 4,704 | |
| Pension contributions | 8,000 | |
| Employment expenses | 5,000 | |
| Other expenses (overheads) | 20,000 | (87,704) |
| Profit before deemed payment | 22,296 |
Corporation tax position
| £ | £ | |
|---|---|---|
| Profit per accounts | 22,296 | |
| Less: Deemed income payment | 34,902 | |
| Employers NIC on deemed payment | 4,816 | (39,718) |
| Allowable loss | (17,422) |
Summary of tax position
| £ | |
|---|---|
| Total PAYE tax & NIC liability as a result of deemed payment (£4,816 + £11,717) |
16,533 |
| Less: corporation tax relief (£39,718 x 20%) | (7,943) |
| Net cost to company | 8,590 |
The deemed employment payment and NIC thereon is an allowable deduction in calculating the taxable profits for the accounting period in which the deemed payment is treated as paid. If, therefore, in our example above the company had a 31st December year end then corporation tax relief would be given in the accounting period ended 31st December 2015.
HMRC provide a very useful spreadsheet that produces the deemed payment calculation saving you the headache. This can be found at www.gov.uk
How many people do you know that have been caught by IR35 and were actually made to pay up? this sounds like a thinly veiled advert to make people buy unnecessary insurance
Hasn’t fatored in the 30k redundacy payment as the company would no longer be viable and need your services.