The IR35 deemed payment calculation converts income your personal service company received from inside-IR35 engagements into a taxable salary figure, so you pay broadly the same income tax and National Insurance as a directly employed worker. Section 54 of the Income Tax (Earnings and Pensions) Act 2003 sets out an eight-step formula, starting with your contract income less a 5% allowance and finishing by dividing the remaining balance by 1.15 to separate the deemed salary from the employer NIC owed on it.
When You Run This Calculation Yourself
The eight-step formula sits in Chapter 8 of ITEPA 2003 and applies only when your PSC is the party responsible for operating PAYE on the engagement. In practice, that means inside-IR35 work for small private-sector clients, where the tax obligation stays with the intermediary.
If your client is a public-sector body or a medium or large private-sector business, the fee-payer deducts tax at source under the separate Chapter 10 off-payroll rules. You do not run this calculation on those engagements, and the 5% flat-rate allowance described below is not available for them. Where you hold a mix of contracts, apply the calculation only to the Chapter 8 income.
What to Gather Before You Start
Pull together everything relating to the tax year running 6 April to 5 April:
- Every invoice your PSC issued for inside-IR35 work, excluding VAT.
- Salary, bonuses, and taxable benefits already paid to you through the year, matching what was reported on RTI or P11D.
- Employer pension contributions your company made on your behalf.
- Employer (secondary Class 1) National Insurance your PSC has already paid on your actual salary.
- Allowable business expenses your PSC covered.
- Capital expenditure on equipment needed for the engagement.
Keeping IR35 income separate from any non-IR35 turnover at this stage prevents the most common source of error later on.
The Eight Steps
Step 1: Take 5% Off Contract Income
Start with the gross amount your PSC received from inside-IR35 engagements during the year, then deduct 5%. This flat-rate allowance covers general company running costs, such as accountancy fees, insurance, and administration, without needing receipts. Apply it only to the IR35 income, not to your PSC’s whole turnover.
Step 2: Add Payments Made Directly to You
If the client paid you anything personally, outside your PSC, that would have been taxable as employment income had you been their employee, add it in. For most contractors this step changes nothing, because everything flows through the company. A signing bonus paid straight to you would be the sort of item that belongs here.
Step 3: Deduct Allowable Expenses
Subtract expenses your PSC incurred that would have been deductible from your earnings if you had been directly employed by the client. The test is that the cost was incurred wholly, exclusively, and necessarily in performing the duties of the engagement. Travel and subsistence for a temporary workplace, approved professional subscriptions, and training tied to the contract are the usual candidates.
If the running total is nil or negative after this step, the calculation stops and there is no deemed payment.
Step 4: Deduct Capital Allowances
Where your PSC bought equipment necessary for the engagement, claim capital allowances on it. Necessity is the point: if the contract required you to supply the item, you can deduct it; if the client would have provided it and your company bought its own by preference, you cannot. Where the equipment is also used on non-IR35 work, reduce the allowance in proportion.
Step 5: Deduct Employer Pension Contributions
Subtract contributions your PSC paid during the year into a registered pension scheme for your benefit. They must be genuine employer contributions of a kind that would not have been taxed as your income if a regular employer had made them. Contributions later refunded do not count.
Step 6: Deduct Employer NIC Already Paid
Subtract the secondary Class 1 National Insurance your PSC has already paid during the year on your actual salary. This prevents you from being charged employer NIC twice on the same underlying pay.
Step 7: Deduct Salary and Benefits Already Paid
Subtract salary, bonuses, and taxable benefits in kind your PSC already paid you during the year and on which you were taxed as employment income. Do not subtract anything you already took off at Step 3, or you will be relieving the same cost twice.
The figure left after Step 7 is a combined pool: the deemed salary plus the employer NIC that will be due on that salary. The last step separates the two.
Step 8: Divide by 1.15 to Strip Out Employer NIC
For the 2026/27 tax year the employer (secondary) Class 1 NIC rate is 15%, so divide the Step 7 balance by 1.15. The result is the deemed employment payment: the taxable salary figure that goes on the RTI submission. The difference between the Step 7 balance and the deemed payment is the employer NIC your PSC owes on top.
A Worked Example
Your PSC receives £60,000 (excluding VAT) from inside-IR35 work during 2026/27. In the same year, the company has paid you £12,570 salary, made £3,000 of employer pension contributions, and paid £500 in employer NIC on your salary. You have £1,200 of qualifying travel expenses and no capital allowances. The client made no direct payments to you.
- Step 1: £60,000 minus 5% (£3,000) = £57,000.
- Step 2: Nothing to add. £57,000.
- Step 3: Deduct £1,200 expenses. £55,800.
- Step 4: No capital allowances. £55,800.
- Step 5: Deduct £3,000 pension contributions. £52,800.
- Step 6: Deduct £500 employer NIC already paid. £52,300.
- Step 7: Deduct £12,570 salary already paid. £39,730.
- Step 8: £39,730 ÷ 1.15 = £34,548 (rounded).
The deemed payment is £34,548. The employer NIC on it is £39,730 − £34,548 = £5,182. Your PSC then owes PAYE income tax and employee NIC on the £34,548, plus the £5,182 employer NIC, all reported through RTI.
When the Result Is Nil or Negative
If the running total falls to zero or below at Step 3 or any later step, the calculation stops and there is no deemed payment for the year. Your PSC has no additional PAYE or NIC to report on the IR35 income. The outcome is simply nil: it does not create a refund and does not carry forward to a later year.
Reporting and Paying What You Owe
Report the deemed payment to HMRC through Real Time Information on a Full Payment Submission, treating it as if it were paid on 5 April, the last day of the tax year. Include PAYE income tax and both employee and employer National Insurance on that figure alongside the year’s other payroll data.
The tax and NIC must reach HMRC by the 22nd of the following month if you pay electronically, or the 19th if you pay by cheque.1GOV.UK. Pay Employers’ PAYE: Overview For the year-end deemed payment that means 22 April for electronic payment and 19 April by post.
Errors in the calculation can attract penalties under Schedule 24 of the Finance Act 2007: up to 30% of the potential lost revenue for a careless inaccuracy, up to 70% for a deliberate one, and up to 100% where the inaccuracy is deliberate and concealed.2legislation.gov.uk. Finance Act 2007 Schedule 24 – Penalties for Errors Late FPS filings trigger separate penalties under Schedule 55 of the Finance Act 2009, with an additional 5% charge where the failure runs beyond three months.
Corporation Tax Relief
Both the deemed payment and the employer NIC your PSC pays on it are deductible when working out corporation tax. HMRC’s Business Income Manual confirms that intermediaries get relief on the full deemed employment payment and the associated secondary NIC.3HM Revenue & Customs. BIM47225 – Specific Deductions: Staffing Costs: Deemed Employment Payments Record the deemed payment as an employment cost in the company’s accounts. The remaining profit can then be distributed as dividends without a second layer of employment tax.
Records to Keep
Retain the workings themselves along with invoices, expense receipts, payroll records, pension statements, and the RTI submission confirmation. HMRC requires PAYE records to be kept for at least three years from the end of the relevant tax year, and records supporting the company tax return for six years from the end of the last financial year they relate to, potentially longer if the return was late or a compliance check is opened.4GOV.UK. Help to Comply With the Reformed Off-Payroll Working Rules (IR35) – GfC4: Record Keeping (Part 3) If HMRC queries the figures years later, the paper trail is what protects you.