How to treat VAT in the IR35 calculation
The VAT flat rate scheme (FRS) was introduced on 24th April 2002 and provides many contractors with an easier way to administer their company’s VAT affairs. Provided a business is eligible to use the scheme, then the amount of VAT it pays over to HMRC is based on a fixed percentage of its VAT inclusive sales. VAT of 20% still has to be charged on the businesses sales but FRS avoids the need to record and reclaim the VAT it incurs on its expenses. Any difference between the VAT charged on sales and the amount of VAT paid is pocketed by the business but what happens to that income where a contractor is caught by IR35?
The starting point for working out the deemed payment is the amount of income received by the PSC in the tax year in respect of relevant engagements
Ordinarily, where a contract falls to be caught by IR35 it is the net income, i.e. exclusive of VAT, that is included in the deemed payment calculation. Where the PSC has joined the FRS however, it is the gross income (VAT inclusive) less the amount of flat rate VAT payable that has to be used.
Example
A contractor supplies their services to a client for a 6-month period ended 31st March 2016. It is agreed that IR35 applies to the engagement. The PSC invoices the client for total fees of £50K + VAT of £10K (20%). The PSC has joined the FRS and pays VAT of 14.5% on £60K, i.e. £8,700. The amount to be included in Step 1 of the deemed payment calculation is £51,300, i.e. £60K – £8,700.
Put another way, the net VAT the PSC has previously kept to itself of £1,300, i.e. £10K – £8,700, is now brought within the IR35 charge.
Hi Andy,
Thanks for the nice article, it’s very useful to know the affect of IR35 on PSC net VAT.
I was wondering if you can throw light on another aspect of VAT for IR35 contract.
Consider an agency between PSC and teh end client. If the agency is paid a commission usually a percentage of the contract rate provided to PSC. And the agency does the deduction at source [employee NI, employeer NI, tax] within the contract rate and pays to the PSC. Should the PSC invoice change the 20% VAT on contract rate to agency or charge the VAT on the net pay to PSC [i.e., after deduction of Employee NI etc.
Many thanks
The PSC charges VAT on the full cost of its services, ie before any deduction of tax & NIC
Many thanks for the quick response.
Andy, should the intermediary/agency pay the full 20% VAT as invoiced by the service contractor or a ‘netted’ down figure after deductions? Thanks
I would just like to clarify how VAT is charged on a deemed payment. My agent has deducted the employee NI. What is left is the deemed payment. This is the invoice charge pulse the 20% VAT. The contract is between my PSC and the agent for the deemed rate not the gross rate I am self billing. i.e. the agent produces my PSC invoices. This is how the agent has calculated my deemed VAT.
IS IT CORRECT?
The PSC charges VAT on the full cost of its services, ie before any deduction of tax & NIC
The PSC charges VAT on the full cost of its services, ie before any deduction of tax & NIC
Andy, for clarification I didn’t think the Agency could deduct Employer’s NIC at 13.8%?
If I am inside IR35 and thus deemed an employee the why should I charge VAT?
HMRC has labelled my contract as that of an employee and employees don’t charge VAT. They can’t have it both ways, that I run a Services company and VAT is chargeable and that I’m an employee and Income tax is chargeable.
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I have just set up a new PSC with a SIC Code of 71122.
I am now endeavouring to get Flat Rate VAT registration, but can not find a matching type of business as far as Flat Rate VAT registration is concerned.
Can you advise please, given that obviously I want the lowest possible Flat Rate for my type of business. The only Engineering biased business Flat Rate that I can find is for a Structural Engineer, which I am not.