If you are caught by IR35 and continue to use your limited company as your trading option and payment structure, you need to take into account the HMRC 5% expense allowance rule.
However, from April 2017, contractors caught by IR35 who work in the public sector will not be able to have the 5% allowance if they choose to continue to use their limited company, because the hirer will be deducting tax via RTI and the 5% rule is no longer allowed.
For private sector based contractors caught by IR35, the 5% rule applies, and we explain here how it works.
Yearly calculation
Contractors and other service companies which receive income caught by the rules of IR35 must carry out a deemed salary/Schedule E calculation each tax year, based on income received from relevant engagements.
HMRC allow an expense allowance equal to 5% of the income received from relevant engagements in calculating the deemed salary. This is intended to cover the following ‘administration’ costs where applicable:
- Premises costs including home as office
- Administration and secretarial support
- Accountancy and tax advice
- Costs of seeking contracts
- Printing, postage and stationery
- Employer’s and Public Liability Insurance
- Training costs
- Computer equipment (if not eligible for capital allowances)
- Bank and overdraft interest
- Hire purchase payments
The 5% deduction is given at a flat rate on gross fees receivable and is not available to employees as an expense which they can draw from the company.
It is simply allowed in the deemed calculation of IR35 salary as a fixed and limited claim against the above expenses.
In granting the 5% allowance, HMRC do not require proof of expenditure and the full 5% is granted, even if there is no actual expenditure whatsoever.
Other expenses
Note that the 5% allowance is only for "administration" and is to cover the ten points above. In addition to the 5% for administration costs, a contractor can also claim direct costs such as travel, computer costs, subsistence, direct training, sub contractors, etc.
Allowances for corporation tax
The 5% is in respect of the deemed salary calculation only and is not taken into account when preparing the company’s accounts and corporation tax computation.
The company accounts will take into account the actual expenses only, which may be higher or lower than the 5% allowance.