IR35: when your client deducts Income Tax and National Insurance from your invoice
This article explains how FreeAgent supports IR35 rules for public and private sector contracts where your client deducts Income Tax and National Insurance (NI) contributions from the amount that you invoice and then pays these to HMRC on your behalf.
For other types of private sector contracts, please read the guidance on how FreeAgent supports IR35 when your company is required to make a deemed payment.
Please note that FreeAgent's IR35 functionality won't be available if you have an unincorporated landlord account.
Before you start
If you expect to work on a contract where the client deducts Income Tax and NI from your invoice, you 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 your screen, select 'Accounting Categories' and complete the required information.
Once you've done this, complete the steps outlined below every time you undertake a piece of work for a client who deducts Income Tax and NI from your invoices under the IR35 rules. If you create a project in FreeAgent for these contracts, do not tick the IR35 checkbox as this only relates to contracts where your company is required to make a deemed payment.
1. Create the invoice
When you complete a piece of work for a contract where the client deducts Income Tax and NI from your invoice, create the invoice in FreeAgent as normal. Select ‘Sales’ as the income category. Don't select the category that you created for tax and NI deducted at source.
When your client pays the invoice, they will deduct Income Tax and NI contributions from the invoice amount and will pay this to HMRC on your behalf. The amount you receive will be the amount of the invoice minus the value of these Income Tax and NI contributions.
For example, if you complete work for a total of £1,200, your client will be deducting Tax and NI before paying you, so you will still create and send them an invoice for £1,200.
2. Split the bank transaction for charges deducted
Once the invoice has been paid and the corresponding bank transaction has appeared in your FreeAgent account (minus the Income Tax and NI contributions deducted by your client), you need to split the bank transaction to explain the amount that your client deducted from the invoice.
To do this, 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 your FreeAgent account and select the payment received from your client. 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 NI that your client deducted at source (i.e. the difference between the amount that you invoiced and the amount that your client paid you). Select this transaction and then choose ‘Sales Refund’ from the transaction 'Type' drop-down menu. Select the new income category you created for tax and NI deducted at source from the ‘Category’ drop-down menu and set the VAT rate to 'Out of Scope'. Select 'Explain Transaction' to complete the process.
Following on from the previous example, once you have invoiced your client for £1,200 and received payment for £1,000, you will need to mark that the invoice has been paid in full in FreeAgent. To do this, navigate to the relevant bank transaction in FreeAgent, select ‘More Options’ and change the value to £1,200. This will create a new ‘Money Out’ transaction with a value of £200 to reflect the amount of tax and NI your client deducted from the invoice.
Next, explain the £200 as ‘Type: Sales Refund’, ‘VAT: Out of Scope’, and choose the category you created to record IR35 deductions.
3. Report the amount that you received to HMRC through RTI payroll
If you choose to take this money out of your company as part of your salary, the final part of the process is reporting the information to HMRC through FreeAgent’s payroll.
To do this, you 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 company received from your client, excluding VAT and the amount of Income Tax and NI that the client deducted, in the ‘Pay Not Subject to Tax or NI’ field. This would be £1,000 in the example above. You will pay the VAT to HMRC through your VAT return as usual.
The 'Basic Pay' field would only be needed if you were taking a salary from the company separately from the money your client is paying you. For example, if you were taking £1900 a month from the company and the client paid you £1000 under IR35, the payslip would contain £1900 basic pay and £1000 tax/NI free pay, which would be £2,900 in total. However, if you weren’t taking £1900 a month from the company, the payslip would only contain the £1000 tax/NI free pay. Please note that the payslip your client sends you will have different year-to-date figures as their payslip will include all the deductions.
Alternatively, if you expect to receive the same amount every month from contracts where the client deducts Income Tax and NI from your invoice, you can edit your payroll profile and enter this information in the ‘Pay Not Subject to Tax or NI’ field of the ‘Monthly Pay’ area.
4. Include this income on your Self Assessment Tax Return
HMRC have said that income earned in this way should be included on your tax return as if it were employment income paid to you by your client.
FreeAgent won’t do this automatically, so you’ll need to add a new set of Employment pages to your tax return and include the total income you invoiced in the tax year, excluding VAT, in box 1...
... and include the income tax (not the National Insurance) that your client deducted from your invoices in box 2.
Select 'Yes' in box 8 to show that the income was earned through an off-payroll working arrangement.