If you fall inside IR35 and use a limited company for your contracts and payment structure, you need to be aware of the 5% expense allowance rule that HMRC permits.
That being said, beginning in April 2017, contractors who work on public sector contracts and fall inside IR35 are no longer able to use the 5% allowance if they continue under limited companies. This is because the hirer will be deducting taxes through RTI, meaning the 5% allowance rule will not be applicable.
On the other hand, contractors who are working on projects for private companies and fall inside IR35 can continue using the 5% allowance rule.
As a contractor, if you fall inside IR35, you would have to calculate your deemed salary or Schedule E every year based on the total income you generate from different contracts.
HMRC allows you to use 5% of your total income for expense allowance when you are calculating your deemed salary. This expense allowance is meant to cover the administration costs of certain expenses like:
The 5% expense allowance cannot be drawn from the company, it must be deducted from the gross income. It has to be used in the deemed calculation of your IR35 salary as a fixed claim for the expenses mentioned above.
When claiming the 5% allowance expense, you are not obligated to furnish proof of the expenditure, and you can benefit from it even if you do not incur the actual expenditure.
It is essential to note that you get just 5% allowance to cover administration and costs of the ten items mentioned above. However, in addition, you can also claim certain direct costs such as computer costs, direct training, hiring sub-contractors, travel, and subsistence.
It is prudent to understand that the 5% allowance is exclusively for deemed salary calculation. You cannot consider it when computing corporation tax and your company’s accounts.
The company accounts have to take into consideration the actual expenses you have incurred for the above ten items, and these expenses can be more or less than the eligible 5% allowance.
Limited Company contracts failing both inside and out of IR35 – read our guide.