Tax Guide for Contractors

IR35

IR35 does not apply to umbrella companies, because the contractor is an employee and is paid by PAYE and expenses – not dividends. The new MSC tax rules of April 2007 have removed MSCs from the scope of IR35: instead, all payments made by an MSC to a freelancer must be made on a PAYE basis, irrespective of the IR35 status of the contract.

Expenses & Dispensations

An “allowable expense” is an expense which may be offset against taxable income or taxable turnover. It must have been incurred wholly, necessarily and exclusively for business purposes. If such an expense is incurred on behalf of an individual on the payroll, the standard
procedure is to account for it as a benefit in kind on the P11D form, and then claim the notional personal tax back under S336 ITEPA2003 (what was S198 of the Taxes Management Act 1970 – indeed everyone still refers to these as ‘S198 claims’) on the individual’s Self Assessment return.

This typically happens when the individual pays for something out of their own pocket, and is reimbursed (effectively tax-free) by the Umbrella company.
This involves a degree of paperwork resulting in no actual tax being paid, so the Revenue sometimes issues “dispensations”. A dispensation essentially says “if you spend up to this amount on this activity, you do not need to account for it on your P11D or make a S198 claim on your income tax self-assessment form”. However, a full record of the expenditure, that is, a receipt, must still be kept, and the amount of the expense is then offset against the turnover in the usual way when calculating profit for Corporation Tax purposes.

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