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IR35: recording income received from contracts where the client’s customer deducts Income Tax and National Insurance

This article explains how FreeAgent supports IR35 rules for public and private sector contracts where the client’s customer deducts Income Tax and National Insurance contributions from the amount that the client invoices. For other types of private sector contracts, please read the guidance on how FreeAgent supports IR35 when your client’s company is required to make a deemed payment.

Before you start

If your client expects to work on a contract where their customer will deduct Income Tax and National Insurance from their invoice, you or your client should create a new income category in FreeAgent for tax and NI deducted at source through IR35 rules.

Select 'Settings' from the drop-down menu in the top-right corner of the screen, select 'Accounting Categories' and complete the required information.

You or your client should then  complete the steps outlined below every time they undertake a piece of work for a customer who will deduct Income Tax and National Insurance from your client’s invoices under IR35 rules.

If a project is created in FreeAgent for these contracts, do not tick the IR35 checkbox as this only relates to contracts where your client’s company is required to make a deemed payment.

1. Raise the invoice

When your client completes a piece of work for a contract where their customer will deduct Income Tax and National Insurance from their invoice, you or your client should raise the invoice in FreeAgent as normal. Select ‘Sales’ as the income category and not the category that you or your client created for tax and NI deducted at source. 

When your client’s customer pays the invoice, they will deduct Income Tax and National Insurance contributions from the invoice amount and will pay this to HMRC on your client’s behalf. The amount your client receives will be the amount of the invoice less the value of these Income Tax and National Insurance contributions.

2. Split the bank transaction for charges deducted

Once the invoice has been paid and the corresponding bank transaction has appeared in your client’s FreeAgent account (less the Income Tax and National Insurance contributions deducted by their customer), you or your client need to split the bank transaction to explain the amount that their customer deducted from the invoice.

To do this, you or your client should navigate to ‘Banking’ from the menu at the top of the screen and select ‘Bank Accounts’ from the drop-down menu. Navigate to the relevant bank account in the client's FreeAgent account and select the payment received from the customer. Choose ‘More Options’ and then edit the amount to reflect the full value of the invoice that was raised. Explain the transaction as an ‘Invoice Receipt’ and save the changes.

Doing this will generate a ‘Money Out’ transaction for the amount of the Income Tax and National Insurance that your client’s customer deducted at source (i.e. the difference between the amount that your client invoiced and the amount that their customer paid them). Select this transaction and then choose ‘Sales Refund’ as the transaction type. Select the new income category you created for tax and NI deducted at source from the ‘Category’ field and set the VAT rate to 'Out of Scope'. Select 'Explain Transaction' to complete the process.

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3. Report the amount that your client received to HMRC through RTI

If your client chooses to take this money out of their company as part of their salary, the final part of the process is reporting the information to HMRC through FreeAgent’s payroll. 

To do this, you or your client should prepare payroll for the relevant month as normal in order to generate a payslip for that month. Select the ‘Edit’ button next to the payslip and then enter the amount that your client's company received from their customer, excluding VAT and the amount of Income Tax and National Insurance that the customer deducted, in the ‘Pay Not Subject to Tax or NI’ field. Your client will pay the VAT to HMRC through their VAT return as usual.

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Alternatively, if your client expects to receive the same amount every month from contracts where the customer deducts Income Tax and National Insurance from the client's invoices, you or your client can edit their payroll profile and enter this information in the ‘Pay Not Subject to Tax or NI’ field of the ‘Monthly Pay’ area.

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