What are Personal Service Companies and what is IR35
People usually work either as an employee or as a self-employed person. However, an alternative is to operate via a Personal Service Company. This means that instead of supplying a service directly as a self-employed person, the service is provided by a company which employs the person instead. Usually the company will only have one employee, who is also a director of the Personal Service Company.
From April 2000 new legislation was introduced to change the tax treatment of such arrangements where the person would have been treated as an employee had the services been provided directly i.e. not via the Personal Service Company.
HMRC often carry out Employment Status reviews to see whether someone is genuinely self-employed or whether they are more correctly treated as an employee. With a Personal Service Company as an intermediary, HMRC cannot decide that a company is an employee of another business. However, if HMRC decide that the circumstances are such that the person would have been an employee but for the intervention of the Personal Service Company, then IR35 will apply. This means that instead of just using PAYE to deal with the actual salary and benefits paid by the service company to the employee, PAYE must also be applied to a deemed payment of salary, calculated according to a set formula.
It is the responsibility of the person providing the service to decide whether or not IR35 applies. If the wrong decision is made, and HMRC decide that IR35 should have applied, then HMRC will seek to rectify the position going forward, but will also seek to recover any further tax and NIC which becomes due for earlier years as a result of the change – together with interest and penalties.
Managed Service Companies
From April 2007 new legislation was introduced to deal with Managed Service Companies, which had often been put in place to get round the legislation covering Personal Service Companies.
A Managed Service Company is an intermediary company between the individual supplying the service and the end user business. In this sense, it is similar to a Personal Service Company. The difference is that the person providing the service does not have control over the Managed Service Company, although they will be a minority shareholder. The legislation also covers what are known as “umbrella” companies. The legislation applies whether the Managed Service Company is based in the UK or overseas.
The effect of the legislation is to deem any payment received by the supplier of the services to be subjected to PAYE, whatever form the payment initially takes.
The Managed Service Companies legislation takes priority over the IR35 legislation – so it is first necessary to see if the intermediary company is a Managed Service Company. Only where this is not the case should IR35 be considered.
IR35 changes
There is now legislation in place which means that where the end client is in the public sector, and the individual supplying the services would have been an employee but for the imposition of another company then the public sector end client must operate PAYE on payments made. It is up to the end client to determine whether or not IR35 applies, though the service provider can challenge the decision.
Similar rules are due to come into force from 6 April 2021 (delayed from 6 April 2020) where the end client is in the private sector, but is a medium-sized or large business. A private business falls into this category if it passes two or more of the following:
- Annual Turnover exceeds £10.2 million;
- Balance sheet assets exceed £5.1 million; and
- There are more than 50 employees.
How can WLH Tax Help
HMRC consider the use of Managed Service Companies or Personal Service Companies to be a form of tax avoidance – legal but something which they are seeking to stop if possible. For this reason, they have introduced special legislation to discourage both of these ways of carrying on a business.
If HMRC suspect that you are operating through either a Personal Service Company or a Managed Service Company then they will open a tax investigation. This could be a Personal tax investigation or a Company tax investigation or both, depending on the circumstances.
WLH Tax are tax investigation specialists and will help you deal with any investigation opened by HMRC into your tax affairs.
If HMRC have already opened a tax investigation where IR35 or a Managed Service Company is one of the issues then please contact us for a free, confidential and no obligation discussion. We are happy to have an initial free of charge meeting with prospective clients.