Personal Services Companies – Watch the PitfallsMany individuals provide services through a limited company. Operating via a limited company offers a number of advantages over a sole trade set-up, including the protection of limited liability and the ability to withdraw profits in the form of dividends thereby saving National Insurance contributions.
However, there are potential problems that can arise where personal services are provided through a limited company, particularly if the individual works exclusively for one client.
The personal services legislation (commonly known as IR35) is anti-avoidance legislation which targets perceived avoidance of tax and National Insurance where, but for the existence of the company, the worker would be an employee of the client. For example, assume Bill provides computer services for his ex-employers, ABC Ltd. To take advantage of the benefits of incorporation, Bill sets up a limited company, D Ltd, and provides computer services for ABC Ltd. If by looking through the company and applying the normal employment status tests Bill would be an employee of ABC Ltd, the IR35 legislation bites. The effect of the legislation is that the worker is treated as having received a deemed payment which is liable to PAYE and NIC. Essentially the aim is restore the same tax and NIC position had the worker been employed by the client, with the effect that the tax benefits of incorporation are lost.
Avoiding the IR35 trap
As noted above, the IR35 rules only apply where, but for the existence of the intermediary company, the worker would be judged to be an employee of the client.
Therefore, to avoid falling foul of the IR35 legislation it is essential that the services are provided in such a way, that if the company was ignored, the relationship would be one of self-employment. There are various steps that can be taken to achieve this.
For example, a self-employed worker would normally provide his or her tools. He would be responsible for organising his or her own time and (subject to agreement with the client) deciding where and when the services are required. He would manage the job, rather than being supervised by a member of the client’s staff. A person providing personal services through a limited company would be advised to organise his or her affairs in this manner to help avoid a challenge that the IR35 rules are in point.
Another key indicator of self-employment is the ability to bear financial risk. A self-employed person will need to use his or her own money (or money that they have raised) to buy the assets needed to run the business and meet the associated overheads. In many cases it will be usual to charge a fixed price for the job and be paid the same regardless of how long the job takes to complete. If they finish ahead of schedule, they benefit from the additional profit and in they run behind, must suffer the additional costs. Again, these features should be replicated as far as possible in a personal service company to avoid an IR35 challenge.
On the other side of the coin, indicators of employment include a regular wage for set contracted hours, a degree of supervision, and the requirement for the worker to do the work himself rather than provide a substitute. Minimising the factors that suggest employment should again help reduce the possibility of an IR35 challenge.
Where personal services are provided through a limited company, the provision of those services should be based on a self-employment model to reduce the risk of an IR35 challenge.