This two-part series will look into how contractors with limited companies may be affected by IR35 and what to do to overcome it.
What is a personal service company?
A Personal Service Company or PSC is the name given to a limited company that has been created by a contractor for the purpose of serving one customer only. If that company did not exist, they would be an employee of the customer. It is also known as an intermediary company. One of the main reasons for creating this company is for the tax advantages.
What is IR35?
When Gordon Brown was the Chancellor, he introduced the Intermediaries legislation in 1999, in an attempt to curb people creating limited companies just to take advantage of the tax benefits. This became more commonly known as IR35 – Inland Revenue (as it was known then) budget press release number 35.
What are the tax advantages of a PSC?
If you have a limited company, you have the following tax benefits:
- You can take out dividends which are taxed after corporation tax. In the past, you did not get taxed on dividends up to the basic rate. However, this tax advantage has now gone and starting from April 2017; you will now have a £5,000 starting allowance just for dividends. As a result, directors who take a minimum salary and the rest as dividends will now be taxed. From April 2018, this tax-free allowance will fall to £2,000.
- As a Director of the company, you can take out a small salary and avoid paying expensive PAYE taxes and in particular the employers NI at 13.8%
- The company that hires you will also save money, as they will treat you as a supplier and they too will avoid having to pay the PAYE taxes if you were their employee
How does IR35 work?
IR35 attempts to establish whether a person is genuinely self-employed through their limited company or whether they are an employee if their limited company was not there. The list below sets out some of the major factors HMRC will consider when deciding whether a contract is caught under the rules. This is not a definitive set of rules but more of guidance to help determine the status of a person’s employment. The rules do not stop anyone from selling their services through a limited company but attempts to remove the tax advantages of doing so.
HMRC checklist |
|
| Mutuality of obligation | Will the work offer to be accepted as an ongoing understanding? Alternatively, is the employer obliged to provide work and is the employee required to take the work? |
| Control | Who has control over tasks undertaken/hours worked etc? |
| Equipment | Who provides all of the necessary equipment? |
| Substitution | Can the individual send a substitute or does he have to do the work himself? |
| Financial risk | Who bears the financial risk? |
| Basis of payment | Is the individual paid a fixed sum for a particular job? |
| Benefits | Is the individual entitled to sick pay, holiday pay, expenses, etc? |
| Intention | Have the customer, and the worker agreed there is no intention of an employment relationship? |
| Personal factors | Does the individual work for a number of different customers and obtain new work in a business-like way? |
What is deemed payment?
If after going through this checklist it is determined that you be an employee rather than self-employed then a deemed employment payment is calculated. A spreadsheet by HMRC can be found by following this link: https://www.gov.uk/guidance/ir35-what-to-do-if-it-applies which can be used to calculate the deemed payment and what taxes you need to pay.
In general, the deemed payment takes all the income received by the company in the year less the allowable expenses (listed below). The PAYE and NI calculated on this value is then due to HMRC if it has not already been paid on your salary and benefits in kind you have received in the year.
Allowable expenses for deemed salary
- Employment expenses
- Capital allowances
- Employers pension contribution
- Employers’ NIC
- 5% of gross income to cover all other expenses
- Deductions for corporation tax
- A claim from the tax paid on the dividends – to avoid double taxation
- Money is withdrawn from the company in an HMRC approved manner such as expenses that qualify as employee expenses and pensions contribution. Pensions contribution can be attractive way to save PAYE and NI – ER’s and EE’s
The next blog in this two-part series will look at some examples and other company types that can be affected by IR35.
Please contact Southside Accountants Wimbledon for your tax and accountancy needs.
Written by Nisha Patel – Chartered Certified Accountant and a Tax Expert.
Leave a Reply