Contractor expenses under private sector IR35 reform: overview
As the inevitable with IR35 starts to look more, well, inevitable, it’s little surprise we’re hearing contractors asking us how they can boost their income by ensuring they are maximising the number of items they can legitimately claim from HMRC as a business expense, writes James Trowell, head of tax and accounting at Dolan Accountancy.
The five per cent casualty
The main expenses casualty of the April framework was the 5% allowance. This allowance was designed as a sort of fixed expenses deduction under IR35, so it 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.
Let’s look a contractor Jim as an example:
Currently Jim has a contract in the private sector that is not caught by IR35 regulations and he is free to claim expenses that are ‘wholly and exclusively’ for business use.
Are you like Jim?
Jim’s circumstances are as follows:
- He has a limited company, Jim IT Ltd, in its first year of VAT registration
- Jim IT Ltd invoices his client £80,000+VAT
- Jim IT Ltd is on the VAT Flat Rate Scheme as a ‘limited cost’ trader, with a 1% discount in his first year of VAT registration (15.5%).
Jim IT Ltd’s gross income is £81,120 (£80,000 + £1,120 VAT flat rate saving).
- £8,424.00 is paid to Jim as a gross salary (also net salary)
- £10,000 is incurred for expenses (no pension contributions made)
- Corporation tax is payable by Jim IT Ltd at 19% (£11,912.24)
- This leaves £50,783.76 paid to Jim as dividends
Jim’s personal tax due on his salary and dividends amounts to £6,616.27 (based on 2018/19 tax rates).
Therefore, Jim’s take-home after tax and NI is £52,591.49 (salary and dividends after tax)
If Jim’s decided inside IR35, post-reform…
So now let’s look at Jim’s situation if it changes and if the April 2017 IR35 changes get extended to the private sector. Jim’s taxation changes dramatically. Let’s keep him on the same income. The VAT flat rate saving is not considered in these calculations and forms the company profits. Let’s say the reforms place the contractor responsible for Employer NI --- the worst-case scenario.
Based on current tax rates, Jim is now facing the following taxation on his income:
Income tax: £16,479.51
Employer NIC: £9,701.23
Employee NIC: £5,033.50
Therefore, Jim's take-home is now £39,905.76 (salary after expenses, tax and NICs).
So as you can see the tax landscape changes dramatically, a hefty £31,214.24 is now payable to HMRC in taxes. Jim will now be paying for his expenses personally. However, he is now saving the £11,912.24 in corporation tax.
Could you absorb an almost £13k tax increase?
As you can see, there’s good reason why Jim won’t want IR35 reformed in the private sector. Or to be precise, there’s twelve-thousand, six hundred and eighty-five reasons! Jim has lost the right to manage his income accordingly. Tax is now deducted from source and he faces paying £31,214.24 in taxes, instead of personal tax of £6,616.27 and £11,912.24 in corporation tax when he is not caught by the regulations.
This is a rough landscape, however, with many factors that can affect these figures. Let’s hope HMRC releases details in its upcoming response to the consultation, to give us some clarity sooner rather than later.
12 items to consider claiming now
In the meantime, Jim – and clearly many other contractors, could do with a reminder when it comes to claiming some of the routinely available expenses during the current accounting period.
- Travel / 24-Month Rule
Travel and associated costs can be claimed when travelling to a qualifying ‘temporary workplace.’ A temporary workplace is defined as a location where you do not expect to work for a period in excess of 24 months, or for more than 40% of the time.
- Overnight Incidentals
For every night that you stay away from home on business, you can claim an overnight incidental. This allowance is claimable without receipt back-up and so is allowable even if nothing is purchased. It is there to cover items such as a morning newspaper, a toothbrush if forgotten etc. For nights away in the UK, you can claim £5 per night and for outside of the UK you can claim £10 per night.
The most common types of insurance required by contractors are professional indemnity and public liability insurance. It’s wise to check your contract to see what you are required to have.
- Pension Contributions
Payments to a pension pot are a tax-efficient way to save for your future -- tax relief will be available whether paid personally or from the company. Note, the ‘best’ method to make payment will be dependent on your personal circumstances.
- Mobile Phone
The provision of a single mobile phone, to an employee, is classed as a tax exempt benefit, subject to certain criteria being met. For the phone to be allowable, the contract must be in the company name and paid for directly from the company bank account. If both these conditions are met, the total cost is 100% allowable (even if there is 95% personal use). If just one of the conditions is not met, then 0% is allowable through the business.
- Internet & Landline Costs
Due to the fact that nearly every UK household now has a landline phone and internet, unless you have a separate business line (in additional to your personal one), internet and phone costs are not allowable through the business at all.
- Computer Costs
Your company is able to purchase any computer equipment it requires. However, please note that to prevent any benefit-in-kind issues, the main use of the equipment should be for business.
- Business Entertainment
A business can entertain its customers/potential customers if there is a genuine business reason, i.e. new contract. Although allowable through the business, there is no corporation tax relief. You also need to be able to prove to HMRC who you entertained and the business reason for the entertainment.
- Staff Entertainment/Gifts
A company is able to entertain its staff for a cost of up to £150 per head, per year. Therefore if you, plus a guest, would like to have a ‘staff party/outing’, as long as the cost is less than £150 per head, you can claim the cost via the business.
- Trivial Benefits
HMRC has introduced 'Trivial Benefits,' allowing you to reward your staff on a one-off occasion, as long as conditions are met. So a company is potentially able to provide employees and directors (not shareholders) with ‘benefits’ which cost up to £50 a time, with no tax or NIC implications, up to an annual cap of £300.
The £50/£300 amounts are limits and not allowances, and therefore receipts must be held to back-up the claims.
- Staff Training
Training is allowable via the company as long as it meets certain criteria. In simplified terms, the training must enhance skills that the employee already has and must not be for an acquisition of new skills. HMRC has also made it very clear that any form of university education is not allowable, as there is ‘dual purpose.’
- Medical Insurance
Medical insurance would be considered a benefit-in-kind. The company should pay for these costs directly and would pay Class 1A National Insurance to HMRC annually. The value of the benefit would also be taxable on the employee. Different methods of taxing the employee depends on whether the company or the employee arranges/pays for the insurance.
- Life Insurance
Relevant life insurance cover can be particularly attractive to limited company contractors because it can be highly tax-efficient. Relatively new to the market, the life insurance policy is structured via a discretionary trust, the payments by the company do not attract a benefit-in-kind income tax and National Insurance Contributions charge.
- Paying your spouse/partner through the company
If your spouse or partner provides assistance with running the company (admin tasks, bookkeeping etc), they should be paid for the work they do. If this is something you think you should be doing, discuss the best options for your spouse/partner and your company with an accountant/tax adviser familiar with the ‘income shifting’ legislation.
These expenses will be in doubt, if IR35 reform goes ahead so get claiming now. But HMRC won’t just be potentially on your doorstep post-April 2019. If you blunder claiming the above now, you could hear from HMRC a lot sooner. If in doubt call your accountant and talk it through. It’s your responsibility remember if you claim for something you shouldn’t have, but two pairs of eyes on something as numerical as contractor expenses are always an advantage.
Editor's Note: This article is an amended version of the original.