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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 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.

Before you start

If you expect to work on a contract where the client deducts Income Tax and National Insurance (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 National Insurance 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. Raise the invoice

When you complete a piece of work for a contract where the client deducts Income Tax and National Insurance from your invoice, raise 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 National Insurance 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 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 FreeAgent account (minus the Income Tax and National Insurance 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 National Insurance 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’ 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 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 National Insurance that the client deducted, in the ‘Pay Not Subject to Tax or NI’ field. You will pay the VAT to HMRC through your VAT return as usual.

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Alternatively, if you expect to receive the same amount every month from contracts where the client deducts Income Tax and National Insurance 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.

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