In the latest in his ‘Keep it Simple series’ Neil Da Costa shows you how to deal with Personal Service Companies, currently a hot topic.
Many UK employees have set up personal service companies (PSC) to invoice their employers, to reduce their PAYE tax liability.
In so doing, they could deduct a lot of trading expenses in computing the company’s trading profits and extract the profits via a dividend, so benefiting from lower income tax rates and saving national insurance contributions.
In deciding whether or not the company is a personal service company, HMRC use the ‘Mutuality Of Obligation’ (MOO) test. They carefully look at the contract to determine if both parties have certain expectations that amount to a de facto employment relationship.
BBC presenter Crista Ackroyd
In a well-known case, which was decided in HMRC’s favour, the courts looked at the TV presenter Crista Ackroyd and found that the BBC controlled exactly what services her company could provide. She was also restricted from engaging with any competitors.
Ms Ackroyd was obliged to provide services to the BBC, who paid her PSC the same fee each month. Under the MOO test, she was for all intents and purposes, a BBC employee. HMRC assessed her PSC on unpaid tax of £420,000.
IR 35 rule
Under IR 35, the PSC is responsible for paying the PAYE on the deemed or assumed salary. The company gets a 5% deduction for expenses. In addition, any salary paid by the PSC and employer’s NIC can also be deducted.
However, the PSC is not allowed to claim the employment allowance as it only has a single employee. The amount is treated as inclusive of employer’s NIC of 13.8%.
The individual has to pay income tax and employee NIC on the deemed salary. To avoid double taxation, the individual can make an election to treat the dividend as coming out of the deemed salary.
Simple Example (Jack and Jack Ltd)
Jack is a TV cameraman. He only works for the TV company and must do all the work himself. The TV company provides him with the camera equipment and pay him monthly.
To reduce his PAYE, Jack sets up Jack Ltd to invoice the TV company.
The TV company pay Jack Ltd a fee of £100,000 a year. Jack Ltd has expenses of £15,000. Jack Ltd has paid Jack a salary of £20,000 and has employer’s NIC of £1,569.
In addition, Jack has taken £60,000 out of the company as a dividend. Jack Ltd is a PSC. Compute the deemed salary that the PSC is responsible for paying PAYE on under IR 35.
Solution To Jack and Jack Ltd
Jack Ltd is allowed a 5% deduction for expenses – £100,000 x 5% = £5,000.
In addition, Jack Ltd can also deduct the salary and the employer’s NIC as PAYE has already been accounted on the salary.
£100,000 – £5,000 – £20,000 – £1,569 = £73,431.
The £73,431 is inclusive of employer’s NIC at 13.8% so represents 113.8%. The deemed salary is therefore 100/113.8 x £73,431 = £64,526
The PSC is responsible for accounting for PAYE on the £64,526 on 22 April following the tax year. To avoid double taxation, Jack can make an election to treat the dividend of £60,000 as coming out of the deemed salary of £64,526.
Extension of the PSC legislation
Public sector employers such as the BBC and the NHS are already IR 35 compliant and would deduct PAYE at source to any consultants as the responsibility has now been passed to the end client instead of the PSC.
As a result of this, it is estimated that 80% of government IT projects suffered delays due to contractors leaving.
HMRC have now decided to extend the rule to the private sector and instead of the owner of the PSC declaring that the company is a PSC, responsibility has been put on the end client. These rules were meant to come into place from 6 April 2020, but have been delayed due to Covid.
Small companies that satisfy at least two of the following three conditions are exempt from the rule:
• Annual turnover of not more than £10.2 million
• Balance sheet total of not more than £5.1 million
• Not more than 50 employees
It is still possible to avoid the PSC rules through umbrella companies and the right of substitution and it is important to seek the correct tax advice to avoid a nasty tax bill.
• Neil Da Costa is a Senior Tax Lecturer with Kaplan. He believes in keeping things simple and making tax fun.