IR35: recording income received from clients' public sector contracts (from 6th April 2017 onwards)
If you have clients who are contractors in the public sector, this article explains how FreeAgent will handle their IR35 requirements after 6th April 2017.
Create a new income category
When a contractor client starts work on their first public sector contract after 6th April 2017, you or they should create a new income category in FreeAgent for public sector taxes deducted at source through the new IR35 rules.
To do this, navigate to the ‘Settings’ area of their FreeAgent account and select ‘Income and Spending Categories’ from the ‘Accounting, Tax and VAT’ area.
Next, select ‘New Income Category’ from the ‘Add New’ drop-down menu and assign a name to the category - we suggest using something like ‘Public Sector Taxes Deducted at Source’ - and accept the suggested nominal code. Select ‘Create Income Category’ to complete the process.
Please note that this part of the process only needs to be completed once in FreeAgent (i.e. before the client raises their first invoice dated 6th April 2017 or later for a public sector contract).
Complete the workflow
Once the new income category has been created, you or your client should complete the steps outlined below every time they undertake a piece of work for a public sector organisation. Please note that if your client creates a project for a piece of public sector contract work in FreeAgent, they should not tick the IR35 checkbox in the project creation area after 6th April. They should only tick this box for projects that relate to contract work in the private sector.
1. Raise an invoice
Once your client is ready to invoice the public sector organisation, you or they should raise an invoice in FreeAgent as normal. Be sure to select ‘Sales’ as the income category, and not the new income category for public sector taxes deducted at source.
2. Split the bank transaction for charges deducted
Once the invoice has been paid and a corresponding bank transaction appears in the client’s FreeAgent account (less tax and National Insurance contributions deducted by the public sector organisation), you or the client need to split the bank transaction to explain the amount that the organisation deducted from the invoice.
To do this, you or the client should navigate to the relevant bank account in their FreeAgent account and select the payment from the public sector organisation. Choose ‘More Options’ and then edit the amount to reflect the full value of the invoice that was raised (e.g. if the client was paid £4,000 for a £6,000 invoice, change the value of the bank transaction from £4,000 to £6,000). Explain the transaction as an invoice receipt and save the changes.
Doing this will generate a negative transaction for the amount of tax and NI that the public sector organisation deducted at source (i.e. the difference between the amount invoiced and the amount paid). You or your client should select this transaction and then choose ‘Sales Refund’ as the transaction type. Select the new income category you created earlier for public sector taxes deducted at source from the ‘Category’ field and set the VAT rate to N/A. Select ‘Explain Transaction’ to complete the process.
3. Report the amount that the client received to HMRC through RTI
The final part of the process is reporting this information to HMRC through FreeAgent’s RTI payroll system.
To do this on a month-by-month basis, you or your client should prepare payroll for the month in question 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 the client was paid by the public sector organisation, excluding VAT, into the ‘Pay Not Subject to Tax or NI’ field. (The client would pay the VAT to HMRC on their VAT return in the usual way.)
Alternatively, if the client is expecting to receive the same amount from public sector contracts every month, you or they can edit their payroll profile and enter this information in the ‘Pay Not Subject to Tax or NI’ field of the ‘Monthly Pay’ area.
Completing this workflow will generate matching revenue and expenditure records in the client’s accounts. As a result, these transactions will neither increase profit nor incur Corporation Tax.
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