Recent and potential IR35 changes now mean the threat of being caught by this particularly unpopular tax legislation has ramped up. Until every public sector engager is proactive, and ensures each working arrangement is given a fair and individual IR35 assessment, contractors will understandably remain concerned about their future in the sector. If and when reform is extended to the private sector, the same fears might well surface.
For the majority of contractors, the consequences of working inside IR35 are well-known. Caught by IR35, and you’ll be required to pay tax and national insurance contributions on your income, just as you would when working as an employee.
With your IR35 status set to ‘inside’, you will no longer be able to pay yourself tax efficiently, and through a combination of low salary and high dividends. Understandably, this is where the outrage surrounding the controversial IR35 legislation lies. When working under the legislation, contractors are forced to pay the same taxes as employees, but without any of the safety, security or statutory benefits which employment brings.
What is often overlooked however, is HMRC’s ‘5% expense allowance’, which currently allows contractors working in the private sector to claim back 5% of income generated through the contract which falls inside IR35, to cover the cost of running a company.
If your contract falls under IR35, HMRC requires contractors to calculate ‘deemed payment’. Put simply this is the amount you have earned through your IR35 caught contract. Given recent public sector changes now mean end clients and agencies are responsible for working out a contractor’s deemed payment, and deducting tax just as they do for employees, HMRC’s 5% expense allowance has been scrapped for contractors working in the public sector.
For the time being, should you work inside IR35, on private sector projects, and through your own personal service company, HMRC does allow you to recoup 5% of your gross income earned through the IR35-caught contract, for the costs associated with running a company.
While this is perhaps insignificant in comparison to the cost of working inside IR35, nonetheless it’s important that you claim this allowable expense to maximise your earnings after tax.
While HMRC does not outline these expenses specifically, the flat rate 5% allowance is designed to cover the costs of running a business. This could be anything from premises and office costs, through to accountancy fees or stationary expenses. This deduction is made automatically without reference to any amounts met by the company, while it is only given in working out the ‘deemed profit’. It’s not taken into account in calculating the intermediary’s profits either.
Contractors working under IR35 – and in this case irrespective of whether it happens to be in the private or public sector – are able to continue claiming tax relief on pension contributions made by the PSC on the contractor’s behalf.
However, recently enforced changes to travel and subsistence (T&S) allowances mean that contractors working inside IR35 should not claim on everyday expenses such as travel, mileage, hotels and meals. HMRC are hot on this, and will reclassify this as earnings, meaning that you will be forced to pay tax and NIC on any incorrectly claimed T&S expenses.
Expenses are also allowed for which a contractor could have claimed a deduction against their earnings under the normal employment income rules, if they had at some stage been employed by the client, and had met those expenses out of those earnings. That said, employment expenses are notoriously difficult to claim, given they must meet the ‘wholly, exclusively and necessarily’ test. In other words, they must be absolutely necessary in performing the duties of employment. In many cases, contractors do not meet HMRC’s criteria for this.
Given the benefits of working under IR35 are minimal to say the least, it’s essential that as a contractor – irrespective of the sector you work in – that you are given a fair and proper IR35 Review, and one which accurately determines your employment status.