Over the last few years, tax issues in this area have become more and more complex. It is now more important than ever to have a basic understanding about your tax status and how it affects your position.
What is a Personal Service Company?
A personal service company, or a PSC, is when a single individual incorporates a limited company and invoices clients through that limited company.
A personal service company tends to comprise of one individual who will be the only shareholder and director, more often than not only having a single client.
Commonly, the individual who becomes a contractor had previously worked as an employee of their client. This approach is popular for service providers who leave their employment to commence contracting on a ‘freelance’ basis.
The reduced rates of tax (via dividend, salary and pension planning), increased daily rate and the ability to obtain tax relief on expenses often results in a significantly better ‘net’ position for the individual.
HMRC Approach to Personal Service Company
In 1999 the Inland Revenue (prior to HMRC), introduced the IR35 legislation which directly deals with personal service companies, specifically looking to capture tax from those individuals who would actually be employees if it were not for the existence of their company.
Therefore those who are genuine freelancers, contractors and independent consultants are not within the parameters of the IR35 legislation and will face no possible repercussions. Unfortunately, the legislation is often open to a rather wide interpretation.
However, PSC’s which are adjudged by HMRC to be ‘disguised employees’ may have to face a potential legal battle and a repayment in income tax and national insurance contributions.
HMRC’s view is ‘disguised employees’ meet the tests of being employed by a company and are trying to minimise their tax liability.
The legislation imposed a restriction on the level of expenses that can be claimed and an effective increase in the tax charged.
Tests of Employment
Factors such as the right of control and how integrated an individual is in the workplace are some of the main tests applied to determine whether someone is self-employed or an employee.
For instance, a contractor who is in control of the work, can control most aspects of the work and will face less involvement from a client will be considered to fall outside the rules. Furthermore, they may also delegate work onto others (known as the right of substitution).
On the other hand, someone who is considered to be an employee will see the employer control aspects such as ‘how’ the work is done and ‘where’ and ‘when’ work is done.
A genuine contractor is also unlikely to be involved in staff events or receive any extra benefits.
Furthermore, they are will not be involved in any pension or share schemes. Someone who is an employee however is likely to be in line for ‘promotions’, attending staff events or other fridge benefits.
Moreover due to new government legislation, employees must be part of a workplace pension scheme.
The Future of IR35 Legislation
HMRC have recently changed the burden of responsibility such that government departments are now taking the tax risk on such individuals.
This has meant many contractors have been released from contracts with TFL and other government bodies. Those working for private or public companies still take the tax risk themselves.
In the long run, the rules as they are can be difficult to enforce and as such we can expect several changes over the coming years which makes the position less appealing for individuals who choose to leave their employment to pursue a career as a contractor. To ensure you are protected, call Wisteria’s tax team on 020 8429 9245.