Using a Personal Service Company
Personal service companies are popular for contractors since they are considered to be a very tax-efficient way in which to operate. However, they’re viewed with suspicion by HM Revenue and Customs, which believes most are set up specifically to avoid tax in a way that’s in breach of IR35 where people are working as ‘disguised employees’. You need to be careful, therefore, how you set up and run your company.
HM Revenue and Customs Crackdown
Public service companies gained a lot of publicity with the news that the BBC was paying some of its top names through them and was subsequently forced to move these people onto its payroll. Such companies generally receive fees from clients, pay Corporation Tax on their profits and the only employee is then paid a salary below their personal tax allowance plus dividends that are tax free within the lower rate tax band (£31,785 for 2015-16).
The Treasury reckons it’s losing over £400 million in tax revenue annually through these companies and so it has set up specialist teams to investigate breaches of IR35 rules. Additionally, the 2015 summer Budget set out plans to crack down on the use of personal service companies, with further actions promised in the Autumn Statement that year.
The aim is to identify those users of personal service companies who are not technically contractors but are instead working in the same way as normal employees. These people are likely to be forced to be put on the client’s payroll and paid under PAYE.
There’s already a change from 2016-17, with dividends above £5,000 being taxed at increasing rates.
Personal service company arrangements that fall foul of IR35 legislation tend to be those where contractors carry out the normal business of the client and are subject to the same controls and benefits as its permanent employees. In these cases, HM Revenue and Customs requires contractors to be paid under PAYE in the same way as other employees, which largely negates the benefits of contracting.
To avoid this happening, do the following:
- Set up a limited company with separate bank account, with yourself as a director and shareholder.
- Create a contract between the company and yourself as an employee so it’s obvious you are separate.
- Ensure every job you undertake has a contract between the client and your company, setting out the services it (rather than you) will provide.
- Receive all contract fees into the company bank account and include them in the annual accounts, with Corporation Tax paid on any profit.
- Pay yourself in the form of a modest salary (to minimise income tax and NI payments) and dividends.
You need to be careful you don’t violate the various rules and regulations that govern personal service companies, especially since these are liable to change (such as, for example, the new dividend tax for 2016-17). If you use Phoenix Cloud Accounting, you have no worries because everything is taken care of for you.