Staff Costs and Subcontractor Expenses

Staff Costs Are Fully Allowable

If you employ people to help run your business, the costs of employing them are legitimate business expenses. This includes wages, National Insurance, pensions, and various other employment-related costs.

Similarly, if you hire subcontractors or freelancers rather than employees, those payments are deductible — though the rules differ, particularly in the construction industry.

Employee Costs You Can Claim

Wages and Salaries

The gross pay you give to your employees is an allowable expense. This is the amount before tax and employee National Insurance are deducted — your full cost of employing them.

Employer's National Insurance

As an employer, you pay secondary Class 1 National Insurance contributions on your employees' earnings. For 2025/26, the employer's NI rate is 15% on earnings above £5,000 per year per employee. This is a significant cost and fully deductible.

Employer Pension Contributions

Under auto-enrolment, you must contribute at least 3% of qualifying earnings to your employees' workplace pension. Many employers contribute more. Employer pension contributions are:

• Fully deductible as a business expense
• Free of employer's National Insurance
• Not taxable as employee income (within annual limits)

This makes pension contributions one of the most tax-efficient forms of remuneration.

Statutory Payments

Statutory sick pay (SSP), statutory maternity pay (SMP), statutory paternity pay, and statutory shared parental pay are deductible. You may also be able to reclaim some statutory maternity and paternity pay from HMRC.

Bonuses

Cash bonuses paid to employees are deductible in the year they're paid. They're subject to PAYE and National Insurance like regular wages.

Benefits in Kind

If you provide non-cash benefits to employees (company car, health insurance, gym membership), the cost is deductible, though the employee may be taxed on the benefit through their P11D.

Training and Development

The cost of training your employees — courses, conferences, professional subscriptions — is a fully deductible staff cost.

Recruitment Costs

Expenses incurred in finding and hiring employees are allowable:

• Job advertising (online, print, agencies)
• Recruitment agency fees
• Interview costs (travel for candidates, if you reimburse them)
• Background check and DBS fees

Hiring Family Members

You can employ family members, and their wages are deductible — but HMRC will check that the pay is reasonable for the work done. Paying your spouse £40,000 per year to answer the occasional phone call will not pass scrutiny.

The pay must reflect genuine work at a market rate. If your partner does genuine bookkeeping work for your business, paying them a reasonable hourly rate is perfectly legitimate and can be tax-efficient, as it uses their personal allowance and basic rate band.

Subcontractor Payments

General Subcontractors

If you hire freelancers or subcontractors to do work for your business, their fees are allowable business expenses. This includes:

• Freelance designers, developers, or writers
• Virtual assistants
• Specialist consultants
• Temporary workers sourced through agencies

The full amount you pay them is deductible. You don't deduct tax from their payments (they handle their own tax) unless CIS applies.

Construction Industry Scheme (CIS)

If you're a contractor in the construction industry, the Construction Industry Scheme requires you to deduct tax from payments to subcontractors and pass it to HMRC.

Key CIS rules:

• You must verify subcontractors with HMRC before paying them
• Standard deduction rate: 20% (for verified subcontractors)
• Higher deduction rate: 30% (for unverified subcontractors)
• Some subcontractors have gross payment status (0% deduction)
• Deductions are only applied to the labour element — materials are excluded
• Monthly CIS returns must be filed with HMRC

The gross payment to the subcontractor (before your CIS deduction) is your allowable expense. The CIS deduction is money you've withheld on behalf of HMRC — it's still part of the cost to your business.

With Accounted, Penny understands CIS rules and always asks about materials when recording construction payments, ensuring the deduction is calculated correctly on the labour portion only.

Employee vs Subcontractor

Getting the employment status wrong has serious consequences. If HMRC decides that someone you've been treating as a subcontractor is actually an employee, you could face:

• Back-dated PAYE and National Insurance
• Penalties and interest
• Obligation to provide employee benefits

HMRC's tests for employment status include:

• Control: Do you control what they do, how they do it, and when?
• Substitution: Can they send someone else to do the work?
• Mutuality of obligation: Are you obliged to offer work, and are they obliged to accept?

If you control the worker's hours, methods, and tools, and they can't send a substitute, they're likely an employee.

Agency Workers

If you hire temporary staff through an employment agency, the agency invoices are deductible. The agency handles the employment relationship, PAYE, and National Insurance.

Record-Keeping

For staff costs, maintain:

• Payroll records (pay, tax, NI for each employee)
• Pension contribution records
• Employment contracts
• Subcontractor invoices
• CIS verification records and monthly returns
• P60s and P11Ds

Common Mistakes

Not claiming employer's NI. It's a significant cost — don't overlook it.

CIS deductions on materials. CIS deductions apply only to the labour element. Always identify and exclude materials.

Misclassifying workers. Treating employees as subcontractors is a serious compliance risk.

Overpaying family members. Employ family members by all means, but pay them a genuine market rate for genuine work.

Track all your staff costs in one place. Start your free trial with Accounted and let Penny handle the categorisation.