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Personal Service Companies
The reputation of Personal Service Companies as a tax planning tool received a severe battering about ten years ago, from which it has never recovered. However, in our view, the soil is much more propitious for use of PSC’s now than it was then.
Release from the PAYE Straitjacket
It’s a truism that those who pay tax on their earnings through PAYE are in a tax planning straitjacket. You have almost no ability to reduce the taxable amount in any way, and you even end up paying tax before you receive the income. Personal Service Companies reached the peak of their popularity in the 1990’s, as a means of escaping from this.
In the most extreme cases, a longstanding employee of a company would leave on Friday afternoon and come back on Monday as a freelance contractor, operating through his own limited company. Typically he and his wife held the shares between them.
The Benefits
The benefits of this arrangement, compared with PAYE, were quite startling: firstly, income which basically comprised an individual’s earnings could be split between him and his spouse or other household members, utilising lower tax thresholds; secondly, they enabled the earnings to be paid out as dividends, thus avoiding national insurance; and, in many cases, it was possible to retain profits within the company and defer, sometimes permanently, paying higher rate income tax on them.
They became so popular, and were so successful in cocking a snook at the PAYE rules, that someone in the Revenue decided the practice would have to stop. Hence IR35.
IR35
This was meant to be the knockout blow to the use of the Personal Service Company “quick fix”. (Ironically, the largest take up of this was in Civil Service departments like the Home Office!) There was a lot of political manoeuvring that went on whilst the rules were being drafted, but the end result was that a Personal Service Company had to account for PAYE and national insurance on all of its income (thus negating all of the above benefit) if it was merely being interposed into what was, in commercial substance and reality, an employment situation.
So if A was an employee of B Limited, and decided to put the intermediary, X in between, all tax planning bets were off.
The problem with, and weakness of IR35 (from the HMRC point of view) is that they decided to use the “employment/self employment” test to decide whether IR35 applied.
This is in some ways an antiquated and obscure test, in reality and is nothing like as clear as the press releases accompanying the new legislation suggested. In fact, it’s very hard to tell in practice whether someone is “really” employed or self employed.
The true statistics will probably never be known, however the impression one gets from following the various cases which have come become before tribunals on IR35 is that HM Revenue & Customs lose the vast majority of them. The reason for this is that the employment relationship depends on a Victorian distinction between “master and servant”. The kind of person who is earning enough to justify a Personal Service Company is very often, by definition, going to be acting far more on his own initiative and responsibility (which is the fundamental test) than is implied by this phrase, and therefore there is almost a presumption that IR35 will not bite.
The Way Forward
Nevertheless, IR35 was sufficiently scary when it first came out to put a lot of people off, and many people effectively reverted to an employment situation. The simple message of this article is: look again at your situation, if you could be getting the benefits we have mentioned.
As well as these benefits, Personal Service Companies also make claiming travel and subsistence expenses very much easier, whether IR35 applies or not. If, as an individual, you contract with a large number of different employers or “clients” as the years pass, there are situations where your travel to, and expense of staying at, the clients premises can be disallowable as “commuting” costs if you contract direct, but can be allowable against your tax if you work through a Personal Service Company.
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