Personal Service Companies

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What is a personal service company?

An individual offering services to a client, therefore being employed by the client will not get the income tax and national insurance advantages that a company would get from offering the same services to the client.

One way in which an individual might seek to avoid being classed as an employee is to form a limited company (a personal service company) and then to hire out his or her services in the name of the company.

This would allow the individual to get the tax and national insurance advantages that are available to a company but not an individual.

Personal service companies have been coming under a lot of scrutiny recently as HMRC are trying to crack down on arrangements that are created purely to avoid income tax and national insurance. For example, someone leaving their employer, setting up a limited company and then working for the previous employer though the new limited company.  HMRC will deem this person to be an employee of the previous employer and tax them as such.

Illustration

Mary works for Jake Ltd. and earns a salary of £60,000 per annum. 

What are her NIC payments?

  • Solution

    Employee Class 1:

    £50,270 – £12,570 * 12% = £4,524
    £60,000 – £50,270* 2% = £195

    Total £4,719

Illustration

Mary owns 100% of the share capital of Mary Ltd. and is employed full time by Mary Ltd. 

Mary Ltd. offers services to Jake Ltd and earns £60,000 per annum from this contract. 

What are the NIC payments of Mary Ltd?

If Mary does not take a salary from Mary Ltd. then there will be no NIC implications for Mary or Mary Ltd.

Anti-avoidance legislation (the “IR 35” legislation) was created to stop this kind of disguised employment but it seems that amendments need to be made to this legislation as personal service companies still exist and are still created.

The legislation applies to relevant engagements, where a worker provides services to a client through an intermediary (usually a company) – wherein, if the intermediary company did not exist, this individual providing services to a client – would be treated as getting income from employment.

For example, if Mary Ltd. did not exist, Mary would be employed by Jake Ltd directly, and therefore receive employment income from Jake Ltd and pay income tax and national insurance on that income.

It is only because Mary Ltd. exists that the services are being offered through the intermediary to save tax.

If an intermediary company receives income from a relevant engagement during a tax year and this income (less allowable expenses) is greater than the worker’s employment income received from the intermediary in that year, then the excess is treated as a deemed salary payment made on the last day of the tax year.

The deemed payment is subject to both income tax and national insurance contributions.

Conditions to be classified as a personal service company:

  • The company enters into a contract to provide services to the client

  • The services are carried out by the individual

  • If the services were carried out under a contract between the individual and the client, then the individual would be regarded as an employee of the client

  • The individual must own >=5% of the share capital in the intermediary company

As a result of the changes introduced by Finance Act 2021, the rules for off payroll working in the public sector (introduced in 2017) will now apply to workers in the private sector where the client is a medium or large sized organization.

Services provided via a PSC to a small organisation

In this situation, the PSC (ie the intermediary company) is required to determine whether or not the IR35 rules apply. 
Where the rules do apply, the PSC is required to treat the income from relevant engagements as if it were a salary paid to the employee, and to account for income tax and class 1 national insurance contributions (NIC) on the deemed employment payment.

Calculation of the deemed salary

Income from relevant engagements £A

Less: 
Statutory deduction (5% × £A) (X) 
NICs paid by employer (X) 
Expenses paid by the employer which would be deductible under employment income rules (X)
Pension contributions by employer (X) 
Salary paid by employer (X) 
Deemed salary including employer’s NICs £B

Less: Employer’s NICs (£B × 13.8/113.8)

Deemed salary £C

Ignore any dividends paid by personal service company

Illustration:

Jake has formed a limited company which is a PSC. Jake is the only employee of the PSC. During the year ending 31 March 2024, Jake will perform services via the PSC for a client which is classified as a small organisation for the purposes of the IR35 legislation. 

The budgeted fee income of the PSC for the year ending 31 March 2024 in respect of relevant engagements is £80,000. The PSC will pay Jake a gross salary of £35,000 for this period.

Solution:

The deemed employment payment will be calculated as follows:

Income in respect of relevant engagements 80,000
Less: 5% deduction  (4,000)
76,000
Less: Salary  (35,000)
Employer’s NIC on salary
(35,000 – 9,100) x 13.8% (3,574)
37,426
Less: Employer’s NIC on deemed payment
(13.8/113.8 x 37,426) (4,538)
Deemed employment payment 32,888

The PSC has the obligation to calculate and pay income tax and NIC on the deemed employment payment.

In order to prevent double taxation, dividends paid by the PSC to the worker out of this income, are exempt from income tax.

Services provided via a PSC to a medium or large sized organisation


In this situation it is the client, rather than the PSC, which is responsible for determining the status of the individual. The client will issue a Status Determination Statement to the individual.

Where it is determined that the IR35 rules apply, the client is then required to calculate and pay the income tax and NIC on the deemed direct payment (DDP). The DDP is calculated as follows:

Payment in respect of services provided(Net of VAT)  X
Less: Direct cost of materials incurred by the PSC  (X)
Less: Deductible employee expenses incurred by PSC  (X)
DDP  X

Illustration

Maria provides services via her PSC to a client which is classified as a medium or large sized organisation. The client has issued her with a Status Determination Statement stating that her services fall within the IR35 rules.

Maria sends her client an invoice for £10,000 (net of VAT). The PSC incurred deductible expenses of £750 and the direct cost of materials in respect of the services provided was £500.

The DDP is therefore £8,750 (£10,000 – £750 – £500). This payment will be chargeable to tax and NICs (employee and employer) in the same way as if Maria was a direct employee of the client.

In order to prevent double taxation, the DDP is deducted from any payment made by the PSC to the worker before calculating the tax and NICs due in respect of such payment. 

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