Personal Service Companies – An Explanation
What are Personal Service Companies? They are basically Limited Companies set up for use by just one person, i.e. a sole trader. The UK Government has identified this entity so that they can differentiate between small and medium enterprises which hire people and those who use them solely for their own benefit.
Examples of those who use Personal Service Companies would be contractors and freelancers in such industries as Information Technology, Oil & Gas, Engineering, Accountants, Locum Doctors and substitute teachers and nurses.
Some freelancers / contractors also have their partner in the company, often as company secretary. However, HMRC will treat these as PSCs if one person is predominantly responsible for the income of the company.
Of course, as one would expect, when Governments see fit to subdivide a group, i.e. those that use limited companies as a vehicle, it is almost always so that they can tax them differently. This case is no different.
Disguised Employees
In 1999, after an outcry in The London Times newspaper, the Government of the day decided to crack down on what they say as ‘disguised employees’. Companies laid off people on the Friday and re-employed them as contractors, or freelancers, on the Monday.
They were doing exactly the same jobs as before for the same company and in the same location. In fact, they even sat at the same desk. They used the same equipment and worked on the same projects.
There was no difference at all – except in their tax status and in their employee rights. They swapped those rights for more money.
The disguised employees gained financially from this as did the companies who used to employ them full time.
Intermediaries Legislation Passed
However, not everyone won. The Government, and specifically the Treasury, lost out.
As we know, the taxman makes a sore loser.
So, the Government created the IR35 tax to catch those disguised employees.
However, the tax didn’t just catch those fake employees but others who had been working on a freelance basis for many years.
One Government Minister admitted that they had caught more in their net than had been intended.
However, that didn’t mean that the Government now intended to give back that tax to contractors.
Umbrella Company Contractors
What happened was that contractors now split into two main groups.
Those who considered themselves to be outside IR35 continued to use Personal Service Companies.
Those who considered themselves to be inside IR35 tax, or caught by it, who joined a new entity called an Umbrella Company.
Umbrella Companies took contractors under their wings. The contractors continued contracting. However, they were treated as permanent employees by their Umbrella Companies.
All the contractors had to give them was time sheets and expenses sheets and the brolly did all the admin. They invoiced the client company, deducting the tax and sent it on to HMRC. They paid the contractor.
Disguised Contractors
Just as the Government had set up the legislation to catch disguised employees, a new type of entity arose – the ‘disguised contractor’.
Contractors, who considered themselves caught by IR35, were thus able to offset some expenses against tax that they couldn’t do as an employee – or IR35 tax payer.
They were able to claim for travel to work from their own homes (or offices) to go to work at a client company. They were also able to offset any overnight expenses they incurred like food and accommodation against tax.
Travel and Subsistence Allowance
However, from April 2016 the UK Government put paid to that. Umbrella Company contractors would no longer be able to offset Travel & Subsistence against tax. That’s unless they were outside IR35.
That was a Catch 22 as they would not be likely to be using an Umbrella Company if they were outside the Intermediaries legislation.
Personal Service Company users would still be able to claim for Travel & Subsistence against tax. That’s provided they were outside IR35.
The average difference between the tax that a PSC contractor would pay compared to one working through a brolly would be around £10,000 a year. That was before the recent legislation on Travel & Subsistence allowances.
Future for Personal Service Companies
So, to conclude, the Government has now defined three different types of small businessman (or woman).
Firstly, there is the small & medium enterprise, which has more than one ‘earner’ in the company and who uses a limited company.
Secondly there is the sole trader who uses the ltd company as a personal service company.
Thirdly, there is the umbrella company contractor whom they treat more or less as an employee in terms of paying tax but who gets none of the benefits of an employee.
There is also the contractor who pays IR35 tax. However, these are so few and far between that the Government only gets a pittance from it every year.
Now that the Government has subdivided contractors into three distinct groups they can now treat them differently for tax purposes.
Expect them to do more of this in the future.
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