Basic principles: how to work out the deemed payment: step three
Paragraph 7 Schedule 12 Finance Act 2000/Section 54(1) ITEPA 2003
Regulation 7(1) SI 2000 No.727
Expenses met by the intermediary
Step Three provides for a deduction to be made in working out the deemed payment for certain expenses met by the intermediary in the year. These are expenses for which the worker could have claimed a deduction against his or her emoluments under the normal employment income rules for his or her taxable earnings from the employment if:
- he or she had been employed by the client, and
- had met those expenses out of those earnings.
From 6 April 2002, expenses met by the intermediary include expenses met by the worker and reimbursed by the intermediary. [Section 38(2) FA 2002 and SI2002no.703 and no.705]
Expenses met by a member of a partnership
From 6 April 2002, where the intermediary is a partnership and the worker is a member of the partnership, expenses met by the worker for and on behalf of the partnership in relation to relevant engagements are to be treated as expenses met by the worker and reimbursed by the intermediary. [Section 38(2) FA 2002/S.54(3)(b) ITEPA 2003 and SI2002no.703 and no.705] However, you should not seek to deny relief in the deemed payment calculation for earlier periods where an expense has been met in this way.
Expenses deductible under Step 3
It is important to remember that the normal employment income rules apply when working out whether a particular expense can be deducted at Step Three. These rules are very rigorous and many expenses met by the intermediary will not satisfy them, see EIM31600.
For example, where a spouse is employed by the intermediary to carry out administrative work for the company then it is unlikely that those wages would have been allowed against the emoluments from a contract with a particular client. Therefore, no deduction will be given at Step Three.
Relief should only be given when working out the deemed payment for the expenses met in that year. Normally this will not be a problem. However, where expenditure is incurred around the end of the tax year relief should only be given for the amount paid out by the intermediary. Where there is an on-going situation this should not be particularly significant, since it is only a question of which tax year the deduction is made in.
Expenses relating to use of intermediary’s vehicle
For years 2000-01 and 2001-02, where expenditure on motoring expenses qualifies for a deduction at Step Three, relief can be given either:
- for the actual running costs of using the car for business travel met by the company (business proportions of expenditure on fuel, insurance, maintenance and so on), or
- for an amount based upon the Inland Revenue Authorised Mileage Rates. These Rates include an element to cover capital costs. Therefore, if they are used no deduction should be given at Step Four for capital allowances.
For years 2002-03 onwards, where
- the intermediary provides a vehicle for the worker and
- the worker would have been entitled to an amount of mileage allowance relief for a tax year in respect of the use of the vehicle if the worker had been employed by the client and the vehicle had not been a company vehicle,
- a deduction is given at Step Three for that amount.
Where the intermediary is a partnership, the worker is a member of the partnership and the worker provides a vehicle for the partnership’s business, then for these purposes the vehicle is to be regarded as provided by the intermediary for the worker.
Travel expenses rules
The legislation treats income earned from the relevant engagements as if it were earned from a single continuing employment with the intermediary (S.54(6) ITEPA 2003). The rules for travel expenses should be applied on that basis when working out whether a particular location is a temporary or permanent workplace, see EIM32000.
Where a deduction is given at Step Three no further deduction is due at Step Seven for that expense (see ESM8210).
Where the intermediary is registered for VAT, use the net expenditure exclusive of any VAT. Where however the intermediary has joined the VAT flat rate scheme, which was introduced on 24 April 2002, it is the amount of the expense including any irrecoverable VAT (i.e. the gross amount) that should be used.