Example Tax Calculations
Connor is an IT security specialist working through C Limited and has been offered a 12 month contract with the MoD, via P Agency. The contract is intended to start in 7 days.
The MoD agree to pay £4,000 per month to P Agency, who take a 10% margin, agreeing to pay C Limited £3,600.
P Agency requests information from the MoD concerning the nature of the assignment and working practices. The MoD is unable to provide answers for security reasons. It informs P Agency it believes that IR35 applies.
P Agency takes a risk averse approach and accepts the view of the MoD without further enquiry. Connor is unable to counter ague this status because he has not worked on site to establish the actual working practices that will truly apply.
C Limited incurs accountancy and other administrative expenses of £175 per month together with the following monthly expenses:
- Public and Employers Liability & Professional Indemnity of £50
- Pension contributions of £400
- Other permissible employment expenses of £100
Connor also purchases at the beginning of the contract computing equipment for £1000 that qualifies for capital allowances purposes and specialist business software for £300.
Connor has a tax code of 1100L.
At the end of the first month P Agency receives payment from the MoD of £4,000 and calculates the following payment to C Limited:
Contract rate payable to C Limited 3,600
Deduct 5% allowance 180
Employers NI (3,420 – 676 = 2,744 / 1.138 x 13.8%) 333
Employees NI (3,420 – 333 = 3,087 – 672 = 2,415 x 12%) 290
Income Tax (3,087 – 917 = 2,170 x 20%) 434
Payment to C Limited (3,600 – 333 – 290 – 434) 2,543
C Limited receives £2,543 and pays
Expenses of 725
Computer and software 1,300
Assuming that P Agency applies the same principles over the year. The total tax deductions made by P Agency and paid to HMRC = (333 + 290 + 424 = 1,047 x 12) 12,564
Under existing IR35 rules the position would be different.
Income derived from IR35 contracts (12 x 3,600) 43,200
Add flat rate (43,200 x 20% = 8,640 – (14.5% x (43,200 + 8,640)) 1,123
Subtotal income derived from IR35 activities 44,323
5% allowance 2,216
Pension contributions 4,800
Permissible employment expenses 1800
Capital allowances and computer software 1,300
Employers NI (34,207 – 8,112 = 26,095 / 1.138 x 13.8%) 3,164
Deemed employment payment 31,043
Employees NI (31,043 – 8,060 = 22,983 x 12%) 2,758
Income Tax (31,043 – 11000 = 20,043 x 20%) 4,009
Total tax liability (3,164 + 2,758 + 4,009) 9,931
Refund due to Connor 2,633
In addition, the tax payment date substantially varies between scenarios. Under existing rules, the deemed employment payment tax liability would not be payable monthly but paid by the company or via self-assessment (payments on account and balancing payment).
It is also unrealistic to expect that P Agency, adopting a risk averse approach, would undertake to collate, review and approve permissible tax deductions, to employ adequate resources to calculate an accurate deemed employment payment and tax deductions. These resources would be too costly to P Agency unless obliged to do so by the reforms.
It would now be interesting to consider the position outside IR35. Assuming that the salary paid to Connor was at the employees NI threshold for simplicity.
Corporation tax (44,323 – 15,960 = 28,363 x 20%) 5,673
Dividend tax on (28,363 – 5,673) a 22,690 distribution 1,106
Taxation paid outside IR35 6,779
Difference between IR35 and Non IR35 (9,931 – 6,779 = 3,152)