IR35 Deemed Payment: what is it, and how to calculate it?

Before diving into the IR35 deemed salary calculations, it's important to note that HMRC has recently updated its guidance on the responsibilities of deemed employers.

A link to the Check Employment Status for Tax (CEST) tool has been added to the sections of the guidance entitled "Who determines if the rules apply" and "If you disagree with a status determination."

The deemed payment legislation, initially published on August 22 2019, has been in place for five years, so any updates are greatly appreciated, writes Dan Mepham, boss at contractor accountancy specialists SG Accounting.

You can view the updated legislative guidance here.

What is Deemed Payment?

The Deemed Payment is a calculation used to determine the tax and NICs liability for a contractor who falls inside IR35. It is the total income subject to PAYE, tax and NICs, as if the contractor were an employee. This calculation ensures that contractors working through intermediaries pay similar taxes to regular employees when their contracts fall under the IR35 rules.

The intermediary (usually a Personal Service Company or ‘PSC’) is responsible for making the deemed payment calculation, and ensuring the correct taxes are paid to HMRC.

Who needs to calculate the Deemed Payment?

The responsibility for calculating and making the deemed payment lies with the intermediary (the PSC or limited company) through which the contractor provides services. However, with changes introduced in recent years, there are distinctions based on whether the client is a public sector or private sector organisation:

Public sector contracts:

• Client's Responsibility: The public sector body (the client) is responsible for determining the IR35 status of a contract. If the contract is inside IR35, the client or the agency paying the intermediary is responsible for calculating and deducting the deemed payment.

Private sector contracts:

• Large and Medium-sized Businesses: As of April 6th 2021, private sector clients are also responsible for determining IR35 status for large and medium-sized businesses. If the contract is inside IR35, the client or agency becomes responsible for calculating and making deductions.
• Small Companies: For end-clients defined as ‘small companies,’ the responsibility remains with the intermediary (the contractor’s PSC). They (the PSC) must calculate the deemed payment themselves.

When to calculate the Deemed Payment?

The deemed payment should be calculated and processed at the end of the tax year (April 5th). However, contractors may also choose to calculate the deemed payment monthly or quarterly to manage their cashflow better and avoid a large tax bill at the end of the year.

How to calculate the Deemed Payment, in eight steps

The deemed payment calculation involves several steps to ensure that the correct amount of tax and NICs are paid.

Below is a step-by-step guide to calculating the deemed payment:

1. Work out the amount received by the intermediary in the tax year - only those payments which relate to the inside IR35 engagements need to be identified. Having added up the total, a flat rate of 5% is to be deducted -- this is allowed to cover expenses such as day-to-day running costs of the intermediary. You do not need to demonstrate this expenditure.

2. Add any payments or benefits paid directly to the worker by the client, rather than to the intermediary, that would have been employment income if the worker was employed directly. You only need to add any payments that were not paid by the intermediary and/or would not otherwise be chargeable to income tax. 

3. Deduct expenses which the worker could have claimed as a deduction under the normal PAYE rules if they had been directly employed by the client. This could include such things as travel or subsistence.

4. Deduct any capital allowances in regard to expenditure that the intermediary incurred which the worker could have claimed if employed by the client and he/she had incurred the costs. You can only claim for capital allowances if the plant or machinery bought is necessary for the tasks required by the engagement.

5. Deduct any contributions that the intermediary had made to an approved pension scheme for the benefit of the worker. Check that the pension scheme was approved and that payments were made directly by the intermediary.

6. Deduct any Employer’s Class 1 and Class 1a NIC that had been paid by the intermediary for the respective tax year, in regard to salary or benefits-in-kind for that year.

7. Deduct any amounts of salary or benefits-in-kind which had been received by the worker from the intermediary that had already been treated as employment income and subject to tax/NIC.

If the figure at this point is nil or less, there is no ‘deemed payment’ and so no further tax or NIC to pay. If not, then proceed to the next step:

8. Deduct the amount of Employer’s National Insurance Contributions on the deemed payment. This means the amount left at step 7 to include Employer’s National Insurance Contributions on the total.

The amount left = the Deemed Payment, and on this amount tax and NIC are due.

When to bring in an accountant

Navigating IR35 regulations and calculating the deemed payment can be complex. Here are some situations when it might be wise to speak to an accountant:

• Complex contracts: When working on multiple contracts with varying IR35 status, an accountant can help ensure accurate tax treatment is applied.
• Changes in legislation: Staying updated with the latest IR35 rules and HMRC guidance/announcements is crucial. An accountant can provide expert advice on compliance.
• Time constraints: If managing the administrative burden of tax calculations becomes overwhelming, outsourcing to an accountant can save time and reduce stress.
• Tax-efficiency: An accountant can offer strategies to optimise tax-efficiency while ensuring compliance with IR35 rules, including working out the deemed payment calculation correctly!