Updated: 13th January 2020
Personal service companies, or PSCs, are limited companies generally established with a sole director who is a contractor. There are many benefits for contractors who operate their own limited company, not least of which is the ability to extract much of their income in the form of dividends, rather than a salary under the PAYE scheme.
There is also a benefit for their client in that no employers’ National Insurance contributions are required. One important aspect to consider when running a personal service company, however, is IR35 legislation.
IR35 attempts to prevent tax avoidance by directors of personal service companies. It is a complex piece of legislation that was first introduced in 2000, but that has undergone revision in April this year.
If HMRC deem a contractor to be within the IR35 legislation when they have previously been paying tax using the benefit of limited company rules, it can cause severe financial difficulty as tax investigators can look back at contracts over many years previously.
If you run a PSC, one of the main issues potentially affecting financial stability is your employment status. You must be ‘outside IR35’ to be regarded as self-employed, rather than an employee of your client.
A problem occurs when HMRC questions your status. They are likely to undertake a tax investigation, and potentially backdate a considerable amount of what they regard as unpaid tax.
So why would they question your employment status?
There can be a fine line between working for a firm as an employee, and working as an independent contractor. Sometimes the work will be identical, and when an employee returns to work for the same company as a contractor, this could be viewed as ‘disguised employment’ by HMRC.
The tax and other advantages obtained by operating under a limited company raise suspicions within HMRC – with a limited company you gain access to beneficial loans via a director’s loan account, payment by dividend rather than a full salary under PAYE, and the right to claim a range of business expenses.
Although your limited company structure generally offers protection from personal liability for you as a director, this scenario has the potential to change once insolvency strikes. You could become personally liable for your company’s debts, particularly if HMRC are chasing you for tax arrears, as they are known to take aggressive action to recover their debt.
Additionally, if your company is liquidated and you have an overdrawn director’s loan account, they will demand that the money is repaid for the benefit of your creditors.
If HMRC decide that your existing or previous contracts fall inside the IR35 regulations, you could become liable for a significant amount of tax. They would look at the tax that you have paid, and then deduct this amount from what your total liability would have been as an employee under PAYE.
The fact that you probably withdraw most of your remuneration as dividends throughout the year means that you have a tax advantage which HMRC want to prevent.
Personal service companies are at particular risk of tax investigations by HMRC. A sudden and unexpected increase in tax liability can cause serious financial issues for your company, and potentially on a personal level if you’re not aware of the risks.
Real Business Rescue can help you understand the legislation affecting personal service companies, and how your business might be affected. We have a network of 78 UK offices, and can offer a free same-day consultation to establish your needs.
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