Personal Service Companies as Tax Avoidance and National Insurance for Employees and Employers after Setting up a Business UK


04 Jan

The blog discusses the avoidance of tax through personal service companies and the national insurance which is provided to the employers and the employees of the companies in UK. The computation of the payment of salary will also be a part of discussion and the rates and earnings under the topic of insurance (also in the case of setting up a business UK) will be considered.

Personal Service Companies and their Role

The avoidance of tax can be prevented by the IR35 provisions by taking help from the services of a company after a party set up a new company UK.

Application and Computation’s Outline

It is a normal practice of the workers after the company formation of UK that they avoid their classification under the tag of employees since the burden of tax and national insurance is lower in the case of self-employed. However, there exists a risk that the workers who make a claim to be self-employed will be considered as employees by the HM Revenue and Customs, resulting in the increased taxation and liability to the charge of penalties, both for the workers and for those who make use of the services.

One method for the avoidance of this pitfall is for the worker to set up a new company UK known as personal service company (PSC) for the provision of services to a client. The worker is both the employee of the PSC and the owner of the PSC in the form of its only shareholder.

The relationship of an employment could not occur between the worker and the client due to the fact that an intermediary PSC exists and so the payments by the client is not subject to PAYE and no payment of NICs is required.

Moreover, there is a possibility for the worker to make an arrangement of the personal service company’s affairs in order to obtain the advantage of tax in the extraction of profits from PSC as compared to the situation in which the worker is self-employed. Hence, the arrangement have benefits for both the worker and the client.

A typical arrangement where a taxpayer called Ada used a PSC called Quality Ltd in order to provide computer services to a business client, named Mr. Evans. Evans was invoiced by Quality Ltd for the provision of services. This payment was made gross by Mr. Evans instead of under PAYE and no payment for the national insurance contributions was required. Then, quality Ltd might have made a payment of salary to Ada (usually only a minimal amount to make sure that a small amount of national insurance contributions had to be paid that gave entitlement to benefits of state such as the allowance of job seeker). Quality Ltd made a payment of corporation tax on its net income after the subtraction of expenses entirely and exclusively suffered for the trade purposes (a more generous basis than the test for the expenses of employment), including the salary of Ada and any employer national insurance contributions. The charge of tax was likely to be at the small profits rate, substantially lower than the additional and higher rates of income tax. Quality Ltd could then have made distribution of post-tax profits in the form of dividends. The dividends are not subject to PAYE for the contributions of national insurance. There was also a scope for the payment of dividends to Ada in a tax efficient way, such as limiting them to the basic rate band so that her liability of tax was covered by the dividend relief for tax. Ada could also spread the payment of dividends over a number of years of tax to take benefit of the basic rate band every year – the comparison of this will be done with the situation in which Ada was self-employed and hence taxable on the entire taxable trading profit on the basis of present year, possibly at the additional and higher rates in the year when the profits were high.

Such type of PSCs were so popular that the tax loss and contributions of national insurance as a result of their use caused serious concerns to the HM Revenue and Customs. As a consequence, now there are anti-avoidance rules that limit the avoidance of tax and contributions of national insurance by workers making an offer of their services through an intermediary, for example, a PSC. These provisions are known commonly as the provisions of IR35.

In a broad manner, the provisions of IR35 are applicable in the case where:

  • The individual or the worker has a duty to perform services for a client; and
  • The performance of such services can be referred to arrangements which have an involvement of a third party (such as the personal service company), instead of being referable to a contract between the worker and the client.
  • If the performance of the services was to be done by the worker according to a contract between himself and the client, they would be considered as employed by the client.

Keeping in view the last condition, after establishing companies registration office UK the usual tests are used to check whether an employee is employed or self-employed.


Calculating the Deemed Payment of Salary

If the rules of IR35 are applicable, then a payment of salary may be deemed to have been made to the worker at the end of the year of tax. The deemed payment is subject to NICs and PAYE. In order to calculate the amount of the deemed payment, the steps mentioned below should be followed:

  • Take 95% of all the benefits and payments acquired in respect of the related engagements by the third party.
  • Add the acquired amounts in respect of the relevant engagements by the worker otherwise than from the third party, if their charge is not done as employment income, but would have been so chargeable in case if the client had employed the worker.
  • Subtract the expenses that the third party has met if those expenses would be subtracted if their payment was made from the earnings liable to tax of the employment by the worker. This also involves the payment of expenses made by the worker and the reimbursement done by the third party. In the case when a third party provides a vehicle, then the mileage allowances up to the statutory amounts are also to be subtracted.
  • In case if the worker would have been able to subtract the capital allowances as they had suffered the expense and employed by the client, then subtract the capital allowances on the expense as suffered by the third party.
  • As a step 5, subtract any pension contributions which are registered and the NIC of the employer paid by the third party in respect of the worker.
  • The amounts received by the worker from the third party that were not subtracted in the step 3, should be subtracted that are chargeable as employment income.
  • In step 7, the amount should be computed that together with the NIC of employer on it, is equal to the amount as a resultant of the step 6 above. This means that the amount in step 6 is to be multiplied by 13.8/113.8 and this amount should be subtracted from the amount in step 6.
  • The result obtained is the amount of deemed income from employment.

For the personal service company, the deemed income from employment is an allowable expense of trade and its treatment is done as made on the final day of the year of tax. If the payment of dividends is done out of this income, their treatment is done as exempt to avoid a double charge tax on the same type of income.

An accounting date of April 5 or shortly near to the date should be held by the personal service company.

Consider the example that the preparation of accounts is done to April 5, the deemed income from employment for the years of 2013 and 2014 is to be subtracted in the company in the year to April 5, 2014, while with a March 31st year end the deemed payment would have to be subtracted in the year to March 31st 2015.

Example of a Personal Service Company

Consider an example, Alison makes an offer of services of technical writing through a company having formation of UK. During the years of 2013 and 2014, the company acquired income of £40000 in respect of relevant engagements as performed by Alison. The company made a payment of a salary of £20,000 to Alison, plus the NIC of employer equivalent to an amount of £1698. The company also makes the payment of £3000 into a scheme of occupational pension in respect of Alison. Alison suffered the expenses of travel equal to an amount of £4000 related to the engagements.

National Insurance for Employees and Employers

Classes of Contributions of National Insurance

The division of the contributions of national insurance is done into four classes, as mentioned below:

  • Class 1, which is divided into primary whose payment is made by the employees and secondary (class 1A and class 1B) whose payment is made by the employers.
  • Class 2, whose payment is made by the self-employed.
  • Class 3, voluntary contributions, whose payment is made in order to maintain rights to some specific state benefits.
  • Class 4, whose payment is made by the self-employed.

Main Principles

Employees make a payment of the class 1 NICs. The employees make a payment of the main primary rate between the threshold of primary earnings and the limit of upper earnings and the earnings ‘additional rate above the limit of secondary earnings. In the case of employers, there is no limit for the upper earnings.

As a part of the HMRC, the national insurance contributions office (NICO) makes the examination of the records and procedures to employers in order to make sure that the collection of the correct amounts of NICs is done.

Both the employers and the employees make a payment of the Class 1 NICs in relation to the earnings of the employees. The NICs are not to be subtracted from the gross salary of employees for the purposes of income tax. However, the contributions of the employers are considered to be the expenses of trade.

Earnings

In a broad sense, the earnings consist of the gross pay, not including the benefits that cannot be converted into cash such as holidays, accommodation, cars and the usage of assets of the employer – these are subject to the contributions of class 1A. It also involves the mileage payments over the amount that is approved and the assets that can be converted instantly, given to the employees. For the contributions of employee pension, no subtraction is made.

It should be noted that the earnings do not include the contributions of an employer to a registered occupational pension or a registered occupational pension. However, the NICs have to be paid on the contributions of employer to non-registered schemes.

Generally, the exemptions of NIC and income tax are a mirror image of one another. An expense with a purpose of business is not treated in the form of earnings. For example, if the reimbursement of an employee is done for the travel of business or for having a stay in a hotel on the business of an employer, which in normal terms, is not considered as earnings.


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