VAT, IR35 and software costs in a UK AI marketing budget

What to take away

Key findings

How HMRC treats software subscriptions as a business cost

HMRC generally treats software subscriptions as allowable business expenses if they are used wholly and exclusively for your trade. That means the subscription cost can be deducted from your taxable profits. But the wording matters. If a tool is used partly for personal purposes, you must apportion the cost and only claim the business share.

For AI marketing tools, the business purpose is usually clear: content generation, ad optimisation, analytics or customer segmentation. Still, HMRC will look at whether the tool is genuinely for the business. A solo director using an AI writer for client work can claim it. The same director using it for a personal blog cannot.

Capital versus revenue is the next question. Most subscriptions are revenue costs, deducted in the year they are incurred. But some AI marketing tools involve a large upfront implementation fee or a perpetual licence. Those may be capital costs, claimed through capital allowances instead. The distinction changes your cash flow and your tax timing.

If you buy a bundle that includes training, support and software, split the elements where possible. HMRC accepts that software is often bundled with services, but you should be able to show a reasonable allocation.

A budget template helps you record these splits from the start, so you are not reconstructing them at year end. See our budget template for the lines to carry.

VAT on UK and overseas AI marketing tool licences

VAT on software subscriptions depends on where the vendor is based and whether you are VAT registered. If you are VAT registered and buy from a UK vendor, the vendor charges 20% VAT. You can usually reclaim that VAT on your return, provided you use the tool for business.

A business must register for VAT once its taxable turnover in any rolling 12-month period is over £90,000, according to the government's Tax Confident guidance. If you are not registered, HMRC's place of supply of services manual says any reverse charge services you receive from overseas must be added to your taxable turnover when you consider the need to register. So overseas AI tool subscriptions that fall under the reverse charge count towards the £90,000 test, even though you do not charge VAT yourself.

If you are not VAT registered, you cannot reclaim the VAT. That makes the effective cost 20% higher than the price before VAT. For a small marketing team, that difference can push a tool over budget.

Overseas vendors are different. If you buy from a vendor outside the UK, the vendor may not charge UK VAT, and you may need to account for it under the reverse charge. The treatment depends on the billing entity, not the brand.

Check each invoice for the billing entity rather than relying on the vendor's marketing site, because the entity that bills you decides the VAT treatment. The full mechanics are in the next section.

Reverse charge VAT when a vendor bills from outside the UK

Reverse charge VAT applies when a UK business buys services from an overseas supplier. For digital services, including many AI marketing tools, the place of supply is usually where the customer belongs. So a UK business buying from a US vendor may need to account for UK VAT on the purchase.

HMRC's place of supply of services manual sets out the practical effect for a VAT registered customer: the UK business accounts for the VAT on services from a non-UK supplier, so there is normally no net tax payable on the transaction, except for businesses that are not entitled to full deduction of input tax. The transaction must still be reported on your return.

If you are not VAT registered, the same manual says reverse charge services you receive count towards your taxable turnover when you consider the need to register. The passage does not say how an unregistered business reports the purchase, so check HMRC's current guidance or ask your accountant before you rely on a figure.

The key test is whether the supplier belongs outside the UK and whether the service is within the scope of UK VAT.

Getting this wrong can lead to penalties and interest. HMRC expects you to apply the reverse charge correctly and to keep evidence of the supplier's location and the nature of the service. If you use a VAT agent, make sure they know about your overseas AI marketing tools.

For the official rules, see VAT Notice 700/1: should I be registered for VAT? and the HMRC manual on the place of supply of services.

IR35 and contractor day rates for AI marketing work

IR35, also known as the off-payroll working rules, decides whether a contractor working through an intermediary is effectively an employee for tax purposes. If the contractor is inside IR35, the fee payer must deduct tax and National Insurance as if they were an employee. If outside, the contractor handles their own tax.

For AI marketing work, the status tests look at control, substitution and mutuality of obligation. A contractor who works set hours, uses your equipment and cannot send a substitute is more likely to be inside IR35. A contractor who controls how they work, can substitute and takes financial risk is more likely outside.

The size of the client matters. The off-payroll rules apply from 6 April 2021 where the client is a medium or large non-public-sector entity, and HMRC's guidance says it is the client who decides whether the rules apply (HMRC guidance CA44, April 2024). Check HMRC's current size tests before you rely on them. If you are a marketing agency with a large contractor pool, you need a status determination process.

Always check whether a quoted day rate is inside or outside IR35, because the true cost to you differs.

If you are budgeting, add employer's National Insurance for inside IR35 contractors. For 2026 to 2027 the employer rate is 15% above the secondary threshold of £417 a month (GOV.UK rates and allowances for National Insurance contributions). For outside IR35, you pay the invoice and the contractor handles their own tax. Our cost guide explains how to read quotes without the sticker shock.

Building a budget line by line with real UK figures

The cost lines and the method for building a budget sit in our budget template and the AI marketing tools costs and budget guide. This section keeps the official rates behind the VAT, payroll and record-keeping lines, and one worked example.

Official UK rates and thresholds for AI tool budgets (October 2026 check)

Official rates and thresholds that set the VAT, HMRC record and payroll costs in this guide, as printed on the source pages.

Here is a worked example for a VAT registered small marketing team. The figures are illustrative assumptions, not market rates or survey data. It assumes £1 = $1.30 for dollar-priced tools, 60 contractor days at £500 a day inside IR35, and a 10% contingency.

Add the lines: £6,000 + £9,000 + £34,500 + £8,000 = £57,500. A 10% contingency adds £5,750, so the annual budget is £63,250.

That contingency matters because many AI marketing tools are priced in US dollars. A weak pound increases your cost. At £1 = $1.20, a platform priced at $11,700 costs £9,750 instead of £9,000, a swing of £750. Our hidden costs article covers the extras that rarely stop at the licence fee.

Where ONS inflation data changes your cost assumptions

ONS inflation data gives you a way to update your budget each year. The Consumer Prices Index including owner occupiers' housing costs (CPIH) is a common measure, but for business costs you may look at the Producer Price Index or services inflation. The ONS publishes these monthly.

In the 12 months to September 2026, the ONS reported CPI services annual inflation of 3.7%, up from 3.4% in August (ONS consumer price inflation bulletin, released 21 October 2026). The services figure is the closer match for software subscriptions, legal review and contractor fees. The ONS publishes a new figure each month, so check the latest bulletin before you set your assumptions.

Software inflation is not the same as general inflation. Some AI marketing tools can raise prices faster than CPI at renewal, so check each vendor's terms. If your budget assumes 2% annual increases but your vendor raises prices by 10%, you will be short.

Contractor day rates also move with the market. When demand for AI skills rises, rates tend to rise.

Apply the services rate to software and contractor lines and the headline CPI rate to training and storage. Vendors often push list prices up by more than the index at renewal, so reprice each line from your own quote. A costs and pricing review each quarter keeps your assumptions honest.

Records to keep so an HMRC enquiry is straightforward

For an Income Tax or Capital Gains Tax return from a trade, profession or business that is filed on time, HMRC's window to open an enquiry closes 12 months after the date the return is filed, and different limits can apply in other cases (HMRC Compliance Handbook CH14530). For a return covering a tax year, the same manual says to keep records until at least the fifth anniversary of the 31 January following the tax year. That page is written for Income Tax and Capital Gains Tax, and it says VAT records are covered elsewhere in the handbook, so check the period for VAT, corporation tax and other kinds of return. Good records make the process straightforward. Keep invoices, contracts, bank statements and a log of business use for each AI marketing tool.

For VAT, keep evidence of the supplier's location and the VAT treatment you applied. If you used the reverse charge, show the calculation. For IR35, keep the status determination statement and any evidence you relied on, such as working practices.

For contractor payments, keep timesheets, invoices and contracts. If you deducted tax under PAYE for an inside IR35 contractor, keep the payroll records. Timesheets matter most inside IR35, because they show the days actually worked. If you treat the off-payroll rules as not applying because of your size, keep evidence of your size and check HMRC's current size tests.

A simple folder structure by tax year works. If you use an accountant, agree who keeps what. The pricing models article explains why vendor pricing can change, which affects your records too.

Common questions

Methodology

The rates, thresholds and dates in this article come from GOV.UK pages, HMRC manuals and guidance, the government's Tax Confident small business site and an ONS bulletin, checked in October 2026 against the text printed on each page. HMRC manual pages carry no printed date, so they are treated as current; statutory dates are stated with their year. The worked example uses the assumptions stated in the text, not survey data.

Cite this

Campaign AI (2026). "VAT, IR35 and software costs in a UK AI marketing budget." campaignai.co.uk. https://campaignai.co.uk/ai-marketing-tools-vat-ir35-uk-budget