If the worst happens and you are caught by IR35 (or simply decide to comply with it) then you will need to calculate a Deemed Payment at the end of each tax year. The procedure for doing this is fairly well-established and non-contentious. The only areas of dispute that normally arise are in the application of the temporary workplace rules for travel and subsistence and whether or not other expenses or capital allowances should be allowable. The basic computation is as follows:
Income received under relevant engagements
Less: 5% expenses allowance
Less: Allowable expenses
Less: Capital allowances
Less: Company pension contributions
Less: Employer NI already paid
Less: Gross salary already paid
Balance subject to PAYE
Less: Employer NI payable
Relevant engagements will be those contracts on which it has been decided the IR35 rules apply. This must include any benefits in kind you have received from the client and any expenses they have reimbursed to you. Note that it is only income actually received under these contracts by 5th April that should be counted. Any invoices not yet paid should be excluded from the calculation.
The 5% expenses allowance is based on the whole income figure before any deductions. This is supposed to be an allowance for the costs of running the company, so other company costs such as accountancy fees or training course are not deductible. It should be noted that the 5% is only relevant for calculating IR35 Deemed Payments. It cannot be treated as an expense in your Statutory Accounts or Corporation Tax computation. You should substitute the actual expenses incurred in these.
Allowable expenses are anything that would be treated as tax free if you were an employee of the client. Travel and subsistence whilst working for the client (but not ordinary commuting) are clearly allowable, but so are less obvious items such as business entertainment, subscriptions to approved organisations, PI insurance, training courses required by the client and itemised telephone calls. Things like stationery, postages, periodicals, office equipment and optional training courses are generally disallowed as they are covered by the 5% allowance.
The only condition for claiming expenses against IR35 income is that they must be incurred wholly, necessarily and exclusively for the purposes of carrying out your duties under the contract, the same as they would for an employee. This is not always easy to determine. A good rule of thumb is whether the expenses would be reportable on a P11D if you were an employee of the client (assuming they have a dispensation).
You should make sure you include both expenses that were reimbursed by the client and those that were not reimbursed but borne by you. Examples might be professional indemnity insurance or training courses required by the client and subscriptions to professional bodies relevant to your work. Training costs are debatable as the IR35 rules specifically exclude these, but only if they are for incurred solely for your own self-improvement. If they are specifically required by the client as a condition of the contract, then there is every reason to treat them as allowable expenses.
Travel and subsistence can also be claimed for attending a client site so long as it is a temporary workplace. This normally means that you must either spend no more than 40% of your working time there or the contract should not be expected to exceed 2 years. This last point can cause confusion as people often assume that a 2 year contract automatically qualifies. If it is not renewed or extended that will probably indeed be the case, but often such contracts are extended mid-term and from that point onwards it is no longer a temporary workplace, even if the extension was merely verbal or simply an expression of future intentions. It is always the expectation that counts for the 2 years.
The same goes for new contracts that happen to be based close to the previous one. A temporary workplace refers to the area itself and it is immaterial how many different assignments you work on there. The Revenues Booklet 480 gives the City of London as an example of this. Consecutive contracts with different clients within the Square Mile count as one continuous engagement for the 2 year rule.
In all cases you must be working on a task of limited duration, which means you cannot claim to be at a temporary workplace if your attendance there lasts for the whole (or substantially the whole) term of your employment contract. This means that agency temps not working through their own companies do not qualify. Note here that it is the contract between you and your own company that counts, not the contract between your company and the client. Your own contract is ongoing and may span several client assignments. Therefore each assignment may be a task of limited duration within the overall contract.
Contractors working through umbrella companies should make sure that they have an over-arching employment contract with the umbrella otherwise they will be in the same position as agency temps. However, this will count as a service contract and be subject to the National Minimum Wage regulations. If you work through your own personal service company rather than an umbrella, you can make sure that your contract with your own company is not a service contract so that it is exempt from the NMW regulations. You should also ensure that your registered office is not the temporary workplace itself otherwise travel there will become ordinary commuting.
Capital allowances can be difficult to claim for most contractors in knowledge-based service industries. The most obvious examples are computers but if you are working at a client site they will probably make a computer available to you. Capital allowances can only be claimed on assets that you have to provide yourself in order to do the work. If you decide to work at home and use your own computer instead, or bring your own laptop to the office and use that instead of the one provided by the client, then this will not qualify for a capital allowance. However, you can make a claim for your own equipment if you are required by the client to work at home, even if it is only occasional. In that case you should deduct a reasonable proportion for your own private use unless it is insignificant.
Company pension contributions are allowable deductions so long as they are paid into a pension scheme as such rather than as your own personal contributions. Remember that company contributions are not topped up by a tax credit and you will not be able to declare them on your own tax return. However, they are particularly tax-advantageous in IR35 situations because you also save NI contributions, both employee and employer, so you may be able to afford a higher contribution than if you made them yourself out of post-tax salary.
You should of course deduct any salary (and associated employer NI) that has gone through your own payroll, although this only applies usually to yourself, not to your wife or partner. Spouse wages are regarded by the Revenue as a company expense and are not deductible against IR35 Deemed Payments. However, you are allowed to deduct wages and salaries incurred by your company in order to do the work required under the contract, the same as any other expense. This would be very difficult to prove normally. Most clients would expect you to do the job yourself without having to delegate work to other people. However, it could be a good way of proving that a right of substitution clause was effective, provided it was brought to the attention of the client and cleared by them. In such a situation, it is unlikely that you would be caught by IR35 at all as few employees are able to sub-contract their work to other people.
The final stage is to calculate employer NI on the balance that remains and deduct this in order to arrive at your Deemed Payment. Employer NI is 13.8% so you need to calculate the fraction 13.8% / 113.8% after first deducting the NI earnings threshold for the year (assuming you have not already done this on your own payroll).
It is important to note that Deemed Payments could be triggered earlier than 5th April if you cease to be an employee or director at any time during the tax year or if you dispose of your shares in the company. In that case, you will need to calculate the Deemed Payment immediately and settle the PAYE liability by the 19th day of the following month. For that reason, if you give up contracting and become an employee in your next job, you may wish to consider staying on as an employee of your own company and giving your new employer a P46 rather than a P45. However, this will put you on a D0 code, which will mean your employer will deduct tax on the whole of your earnings without allowing anything for your real tax code. You may then have to claim a tax rebate at the end of the tax year.
There is a bit of leeway on the actual payment of PAYE relating to Deemed Payments. The Revenue expects the numbers to have been calculated by 19th May when the P35 is due but do allow you to estimate the amount of PAYE due if there is any uncertainty about the exact amount. In that case you need to tick a box on the P35 stating that the figure is provisional. You then have until the following 31st January to calculate the exact figures and if you overpaid you can have a refund. If you underpaid they will charge you interest but they will not charge penalties. This gives you extra time to decide whether your engagements really are caught by IR35 or not. However, this concession only applies to Deemed Payments at the year end, not to those arising during the tax year as described in the previous paragraph.
Finally, it should be noted that the Deemed Payment is fully deductible by your company against corporation tax. That is just as well otherwise the same income would be taxed twice, something even this current Government has refrained from doing!