Becoming A Personal Service Company

Working within a Personal Service Company (PSC) is something that many self-employed contractors consider, but it is very important that they are aware of all the facts before they take the plunge.

What is a PSC?
An exact definition of the term Personal Service Company does not feature in any HMRC guidelines but rather PSCs are explained through examples. According to HMRC, a PSC is an intermediary, or in other words, a business structure which contractors use to manage their finances tax efficiently and to create a professional image. The company sells work of the individual who owns and operates the company. This is how a limited company works and therefore, it is considered to be a PSC. However, HMRC does also suggest that any other intermediary that cannot be defined as a Managed Service Company (MSC) might be able to be defined as a PSC for IR35 purposes.

MSCs are companies which were designed to minimise tax payments for contractors but instead of each individual forming their own company and taking on all associated responsibilities of doing so, the business was managed by the MSC, a third party. An MSC would take on a group of contractors as shareholders who would receive minimum wage salaries and the rest of the income as dividends. All administrative, tax and secretarial duties would be fulfilled by the service provider which would charge a fee for these services. Quite simply, these companies allowed contractors to avoid tax via PAYE and therefore have higher take home earnings while not having to undertake corporate responsibilities. Legislation passed in 2007 prevented such companies from functioning in the same way, forcing MSCs to either withdraw their services altogether or switch to PAYE operations. It is therefore vital that contractors limit the corporate work done by third parties and are fully aware of the legislation to ensure they are not guilty of tax avoidance.

Tax compliance within a PSC
It was the introduction of IR35 legislation that saw the creation of MSCs and it is still a difficult tax issue for contractors today. Being IR35 compliant is essential for contractors, especially as they are closely watched by HMRC to ensure that they are. To be considered as a PSC in the eyes of HMRC, every contract must be considered as IR35 compliant. The Revenue considers limited companies to be a risk in terms of tax avoidance so every contract must demonstrate that the relationship between the parties is not one of employer/employee. If it does appear this way, then the contractor is considered to be employed directly by the client and not through the intermediary PSC or limited company. They would then have to pay PAYE tax as normal. All contracts therefore must demonstrate a client/contractor relationship.

Tax advantages within a PSC
An average self-employed professional might find themselves earning an amount of money that puts them into a higher income tax bracket. To get around paying the larger amount, contractors can form their own limited company. Within it, they can pay themselves a very small salary, from which PAYE tax would be deducted and then they can take the rest of the money as dividends. Paying corporation tax and minimal PAYE tends to work out as less than the high amount of income tax many contractors would have to pay as self-employed workers. Contractors within their own limited company can also claim all expenses against their income whereas self-employed contractors can only claim some.

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