Since April 2000 anti-avoidance legislation – known as ‘IR35’ – applies to individuals who would be employees of their clients if they didn’t use a service company.
HMRC has designed a tool which provides its view on whether:
- the intermediaries legislation (known as IR35) applies to an engagement
- the off-payroll working in the public sector rules apply to a public sector engagement
- a worker should pay tax through PAYE for an engagement.
HMRC has stated that it will stand by the result given unless a compliance check finds the information provided isn’t accurate. If IR35 applies, all payments to an intermediary are treated as if they were employment income of the worker and the intermediary must pay any tax and NICs due. It ensures that a similar amount of tax and NICs is paid as if the worker had been directly employed by an organisation instead of via an intermediary.
IR35 calculation
The IR35 calculation has eight steps. Each step, other than Step 7, is on cash basis for both tax and NICs. Records must therefore be kept on both a cash basis for IR35, and an accruals basis for accounting and other tax requirements such as corporation tax.
HMRC provides a deemed employment payment calculator.
To calculate the deemed employment payment manually, you will need to follow the steps below:
Step 1 – deduct 5% from your off-payroll income
Add up the total amount of all payments (using the VAT exclusive amounts) and other benefits received by the service company in that year in respect of all IR35 engagements.
You then apply a flat rate 5% deduction from this income for general expenses, which represents a round sum expense allowance designed to cover the extra costs of working through a service company. There is no requirement that the company actually spent 5% on this sort of expense – it may spend more, less, or nothing at all.
Step 2 – add payments made directly to the worker
Add any payments or benefits paid directly to the worker by the client, rather than to the intermediary, that would have been employment income if the worker was employed directly.
Step 3 – deduct expenses
Deduct expenses paid by the intermediary in the tax year that relate to the relevant engagements. In general, the expenses must have been incurred ‘wholly, exclusively and necessarily in the performance of the duties of the employment’.
Where off-payroll working rules apply, each engagement will be regarded as a separate permanent employment for the purposes of travel and subsistence expenses. This means that you can’t claim expenses for travel and subsistence if you regularly commute from home to a workplace for an off-payroll engagement.
Expenses include:
- incidental overnight expenses
- work-related training provided by clients or agents (but not by the service company)
- professional fees and subscriptions
- professional indemnity insurance (PII).
Step 4 – deduct capital allowances
This applies to plant or machinery bought for the purpose of the performance of the tasks required by the engagement. You will only get relief if the duties of the engagement meant that the intermediary had to provide the equipment in question. If the intermediary purchases the equipment out of choice then you can’t claim the deduction.
You cannot claim the full value of items which you also use for outside engagements where the off-payroll working rules don’t apply. You must reduce the capital allowances you enter by the proportion you use the asset outside the off-payroll engagements.
Step 5 – deduct pension contributions
Deduct any employer contributions to a registered pension scheme.
Step 6 – deduct employer NICs
Deduct any Class 1 and Class 1a NICs paid to HMRC by the intermediary in the tax year on the salary and benefits paid to their worker.
Step 7 – deduct salary and benefits already paid to the worker
Deduct the amount of salary and benefits paid by the service company to the worker that has been taxed as employment income. If the figure is nil or a negative number, there is no deemed employment payment and no further employment taxes to pay.
Step 8 – deduct employer NICs on the deemed payment
Deduct the employer’s NICs on the result above.
Pay tax and NICs on the deemed payment
When all these steps have been completed, the result gives the individual’s deemed employment income from contracts within IR35. The service company is required to pay over the PAYE and NICs due, using the RTI system by including the deemed employment payment on an FPS on or before 5 April.
Normal reporting deadlines apply. However, because of the difficulties in carrying out the calculation within this timetable, estimated figures can be used. If the tax and NICs are paid late interest is charged, but there are no penalties. The company should report these on an Earlier Year Update (EYU) submitted on or before 31 January following the end of the tax year. By concession, there are no penalties as long as the tax and NICs are paid by 31 January following the end of the tax year.
Example:
Total income received by the service company £50,000, wages paid to the worker £8,000, pension contribution made by the employer to a registered pension scheme £3,500.
| Step 1 | Total sum received | 50,000 |
| Less 5% | (2,500) | |
| Step 2 | Add Payment made directly to worker | 0 |
| Step 3 | Less Expenses | 0 |
| Step 4 | Less Capital allowances | 0 |
| Step 5 | Top of Form
Employer’s pension contributions Bottom of Form |
(3,500) |
| Step 6 | Employer’s NIC | 0 |
| Step 7 | Salary paid | (8,000) |
| Balance | 36,000 | |
| Step 8 | Employer’s NICs on attributable earning | (4,365.55) |
| (36,000×13.8/113.8) | ||
| Deemed earning | 31,634.45 | |
| Employee NIC on deemed earning | ||
| (31,634.45×12%) | 3,796.13 | |
| Total NIC due (4,365.55+3,796.13) | 8,161.68 |
Article from ACCA In Practice