The deemed employment payment calculation

Q: What mistakes do contractor companies make?

Waiting for the accounts. The deadline follows the tax year, not the company's year end. A provisional figure must be on the Full Payment Submission by 5 April. Claiming business expenses at step 3. Only expenses an employee could deduct qualify. General running costs of the company are what the 5% allowance is for. Deducting unpaid National Insurance at step 6. HMRC says the deduction is only for contributions actually paid. Mixing engagements. Only income from inside IR35 work for small or overseas clients goes in. Fees already taxed by a fee payer under Chapter 10 are dealt with separately. Forgetting the dividend claim. Paying out the post tax profit as dividends without a section 58 claim taxes it twice. If the status decision itself is uncertain, start with the employment status tests. If HMRC opens a check into your return, tax investigation insurance pays your accountant's fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

When IR35 applies to work for a small private sector client, the contractor’s own company must work out a deemed employment payment under section 54 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) and pay PAYE tax and Class 1 National Insurance on it. The calculation starts with the fees received from inside IR35 engagements in the tax year, takes off a flat 5% and certain costs, salary and employer National Insurance already paid. The payment is treated as made on 5 April and reported on a Full Payment Submission on or before that date.

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When does a company need to work out a deemed employment payment?

The calculation belongs to Chapter 8 of Part 2 ITEPA, the original intermediaries legislation. Section 50 applies it where the client qualifies as small or has no UK connection, the conditions in sections 51 to 53 are met for the intermediary, and the worker receives (or is entitled to) a payment or benefit from the intermediary that is not employment income. Where the client is medium or large, or a public authority, the client decides status and the fee payer deducts tax instead, so no deemed employment payment arises for that engagement. Our page on small clients and the off payroll rules explains how size is tested.

GOV.UK guidance says the company does not need to do the calculation if the employment income it paid the worker in the tax year equals or exceeds what it received for the inside IR35 engagements. A single deemed payment covers all relevant engagements in the year (section 50(2)), but where the company supplies more than one worker the calculation is done separately for each.

What are the steps in the calculation?

Section 54(1) sets out eight steps. HMRC’s Employment Status Manual explains each one from ESM8135 onwards.

Income. Take all payments and benefits the company received in the tax year for the relevant engagements and reduce the total by 5%. Use the figure excluding VAT; under the VAT flat rate scheme HMRC says to use the gross amount less the flat rate VAT payable (ESM8175). Use income before any Construction Industry Scheme deduction (section 54(2)).
Direct payments. Add anything the worker received for the engagements from someone other than the company that is not already taxed as employment income but would be if the client employed them.
Expenses. Deduct expenses the company met that the worker could have deducted as an employee of the client. The normal employment income rules apply, so many company costs fail this test. GOV.UK says each engagement is treated as a separate permanent workplace, so ordinary commuting to the client’s site is not deductible. Our page on contractor expenses inside IR35 goes through common items.
Capital allowances. Deduct allowances on equipment the worker could have claimed as an employee, reduced for use outside the engagement.
Pension contributions. Deduct employer contributions the company paid for the worker into a registered pension scheme.
Employer National Insurance already paid. Deduct the employer Class 1 and Class 1A contributions the company actually paid for the year on the worker’s salary and benefits. GOV.UK says this is the amount paid after any Employment Allowance.
Salary and benefits. Deduct salary and taxable benefits the worker received from the company in the year, excluding anything already deducted at step 3. If the result is nil or negative, there is no deemed employment payment.
Employer National Insurance on the deemed payment. Treat the step 7 result as the deemed payment plus the employer National Insurance due on it, and take that National Insurance out. HMRC’s formula at ESM8220 is the step 7 figure multiplied by 100/(100 + the employer rate) where salary already exceeds the secondary threshold.

The 5% at step 1 is a notional allowance for running costs and does not need to be evidenced. HMRC confirms it is used only in this calculation and is not deducted in working out the company’s profits.

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What does a worked example look like for 2026 to 2027?

Illustration only. A contractor’s company receives £60,000, excluding VAT, from an inside IR35 engagement with a small client in 2026 to 2027. It pays the contractor a salary of £12,570, pays employer pension contributions of £5,000 and meets £1,000 of expenses that would be deductible for an employee. The contractor has no other income and is not a Scottish taxpayer. For 2026 to 2027 the employer Class 1 rate is 15% above a secondary threshold of £5,000, so employer National Insurance on the salary is £1,135.50. The example assumes no Employment Allowance is claimed.

Step	Item	£
1	Income from inside IR35 engagements	60,000.00
1	Less 5% flat allowance	(3,000.00)
3	Less allowable expenses	(1,000.00)
5	Less employer pension contributions	(5,000.00)
6	Less employer National Insurance paid on salary	(1,135.50)
7	Less salary already taxed	(12,570.00)
	Result at step 7	37,294.50
8	Employer National Insurance on deemed payment (37,294.50 x 15/115)	(4,864.50)
	Deemed employment payment	32,430.00

The deemed payment is taxed as earnings from the contractor’s employment with the company. With the personal allowance used by salary, income tax at the 20% basic rate is £6,486. Employee National Insurance is worked out on an annual earnings period: total earnings of £45,000 are £32,430 above the £12,570 primary threshold, giving £2,594.40 at 8%. The company also pays the £4,864.50 employer National Insurance. Total PAYE due is £13,944.90. In practice, payroll software or HMRC’s Basic PAYE Tools works out the figures.

When is the deemed payment treated as made and how is it reported?

Section 50(3) treats the payment as made at the end of the tax year, 5 April. Section 57 brings it forward to immediately before an earlier event, such as the company ceasing to trade or the worker ceasing to be a director, shareholder or employee. Income from the engagements received after that event is still included.

GOV.UK guidance says the deemed payment should be reported on a Full Payment Submission on or before 5 April, and included on the P60 issued by 31 May. If the figure cannot be finalised in time, the company can:

report a provisional deemed payment on a Full Payment Submission on or before 5 April and pay the tax and National Insurance on it;
report final figures on an Earlier Year Update or further Full Payment Submission by the following 31 January; and
pay any balance by that date.

Interest runs on the balancing payment but HMRC says no late payment penalty is charged. The contractor includes the deemed payment, and the tax on it, as employment income from the company on their Self Assessment return.

How does it affect corporation tax and dividends?

The company deducts the deemed payment and the employer National Insurance on it in computing its taxable profits, but only for the accounting period in which the deemed payment is treated as made. HMRC’s company example at ESM8270 shows profits falling to a small residue once both are deducted. VAT is not affected: the company still charges VAT on its fees.

To stop the same income being taxed twice, section 58 lets the company claim to set the deemed payment against dividends it pays, in the same or a later tax year. The claim is made by notice to HMRC within five years after 31 January following the tax year in which the dividend is paid. Without a claim, the dividend is taxed again in the shareholder’s hands. Our pages on salary versus dividends and company pension contributions explain the usual position outside IR35.

What mistakes do contractor companies make?

Waiting for the accounts. The deadline follows the tax year, not the company’s year end. A provisional figure must be on the Full Payment Submission by 5 April.
Claiming business expenses at step 3. Only expenses an employee could deduct qualify. General running costs of the company are what the 5% allowance is for.
Deducting unpaid National Insurance at step 6. HMRC says the deduction is only for contributions actually paid.
Mixing engagements. Only income from inside IR35 work for small or overseas clients goes in. Fees already taxed by a fee payer under Chapter 10 are dealt with separately.
Forgetting the dividend claim. Paying out the post tax profit as dividends without a section 58 claim taxes it twice.

If the status decision itself is uncertain, start with the employment status tests.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.