The concept of the “Personal Service Company” (“PSC”) has come into the lexicon of UK Tax and Accounting over recent years, however it has no legal definition.
Characteristically a PSC will normally:
- Supply the services of one individual (although sometimes supplying the services of two or more people can fall into this category)
- Supply services rather than goods
- Be under the control of one shareholder (even if shareholdings are split with family members)
- Many individuals using PSCs will work via Agencies
- The IR35 tax rules will be normally be a concern
- Services are often supplied to one main client at a time
PSCs operate over a vast number of sectors, eg Computing/IT, Engineering, Design, Consulting, Medical, Social Work, Legal, Accounting.
This guide is part of a series. This is the index:
- Index to our PSC Guidance
- Whitefield PSC services
- PSC Basics – including set up and closure
- IR35 & Related Issues
- Tax and VAT for a PSC – including Corporation Tax, Income Tax, NI, PAYE and VAT
- Expenses for a PSC
- Accounting for a PSC – including bookkeeping, invoicing, receipts, dividend administration
- Practical Issues for a PSC – some of the questions and issues our clients raise reguarly
- Whitefield PSC Spreadsheet
- Context and History
- Choice of Trading Structure
- Umbrella Companies
- Managed Service Companies and Composites
- Hybrid Tax Schemes
- Setting up a PSC
- Pausing a PSC
- Closing a PSC
The use of a private limited company as a trading vehicle for contractors, consultants, freelancers and similar, known as a “Personal Service Company” (“PSC”) has grown steadily in popularity over recent years, but its not new – our MD has been looking after PSCs since the mid 1980s.
In March 1999 a budget press release entitled “IR35” heralded a major change in the attitude of HMRC to personal service companies – previously the attitude had been benign, but from April 2000 new rules have been operated to restrict the flexibility and tax breaks of PSCs. These rules are still commonly known as IR35, after the press release.
Later, an attack against so called “Income Shifting” via family shareholdings in small companies under S660a (also known as the Settlements Legislation and by the test case, Arctic Systems), was experienced by PSCs; this has now been in limbo for some years, but there is an outstanding commitment by the Government to resurrect it when the economy improves.
In April 2007 legislation blocked the use by contractors of so called “Composite Companies” and “Managed Service Companies” – this legislation does not affect the services that we offer.
In April 2017 IR35 in Public Sector Contracts was reformed significantly, with a stated intention to roll out these reforms to the Private Sector from April 2021 (put back from 2020 due to Coronavirus).
This section of our website is written to give guidance to our clients who have their own company or are thinking of operating though one; the content will be of general interest to many other business as well. Non clients are welcome to make use of the guidance, but should take advice from their own accountant about its applicability to their circumstances.
The content on our website is for guidance only, and personal advice should be sought on how circumstances apply to your own situation. No responsibility is accepted for action taken or not taken based solely on the contents of this guide.
Within our website we often refer to “Contractors” as a convenient description for individuals operating through PSCs. However this guide is applicable to anyone operating a small service company, and they may be described as “Freelancers”, “Temporary Workers”, “Consultants” or similar. Likewise although use of PSCs is prevalent in the IT and engineering sectors, this guide applies to any service activity provided through a limited company.
Whitefield have over 30 years experience in the sector – long before IR35, and long before the proliferation of contractor accountancy firms.The content on our website is intended to be a practical guide, and is also tailored to our style of working. Because of this some legal and tax concepts have been simplified in their description so that their practical effect is clear – we are happy to expand on technical details on request.
There are several trading structures available to UK businesses:
- Sole trader – This is the most simple of structures, in the form of “J Smith t/a Smith Consultants”. The business is regarded for legal and taxation purposes as an extension of the traders person.
- Partnership – One up from a sole trader, the trading style is “J Smith and N Smith t/a Smith Consultants”. Although subject to separate taxation rules, partnerships are an extension of the legal personalities of the individual partners.
- Private Limited Company – The most common form of corporate structure, in the form of “Smith Consultants Limited”. The company is owned by its shareholders, run by its directors, and has a separate legal personality and tax status. Although the directors and shareholders will often be the same persons, the roles are in fact separate and should not be confused. A Personal Service Company (PSC) is a form of Private Limited Company – there is no separate legal definition of a PSC, its a practical distinction.
- Limited Liability Partnership – This is a hybrid between a partnership and a private limited company. It is taxed in the same way as a partnership, but has limited liability like a company. Its of no interest to a contractor.
- Public Limited Company – This is a “grown up” form of the private limited company, in the form of “Smith Consultants PLC”. A public company can offer its shares for sale to the public, via a stock market listing or similar, a private one cannot; the quid pro quo for this is that public companies are subject to more stringent audit, capital and disclosure requirements, to the extent that they are not a viable structure for small businesses.
- Other structures – There are more specialist structures available, eg charities, trusts, guarantee companies, offshore companies, but these are outside the scope of these notes.
- Offshore Companies – If you are working in the UK, and are UK resident, then offshore companies never offer any tax saving.
For Contractors and Freelancers the main reasons for using a PSC are:
- Tax Law – when working through an employment agency you cannot be self employed or in partnership as tax law prohibits it. Therefore the choice is either being an agency employee, working via an Umbrella Company, or working through your own company
- Tax Efficiency – provided income is not caught by the IR35 regime, the tax liabilities via a personal service company can be lower than liabilities operating as a sole trader or employee.
- Preference of Client / Agent – many agencies, or client companies if you are working direct, prefer you to use a company.
- Availability of work – many vacancies now stipulate limited company only.
- Better rate – a contractor operating through a PSC will normally be able to achieve a better rate from their client/agency.
- Liability protection – a company gives limited liability, and this can be of importance in protecting against negligence or solvency risks. However this is a complicated area, and a company will not automatically give protection; ask for more details if this impacts on you.
An Umbrella company is an alternative to running your own PSC if you work via an agency or for one main client.
You become an employee of the Umbrella company, and they invoice your agent or client.
Pros and Cons:
- An umbrella relieves you of the time and cost burden of running your own company
- You must be an employee of the umbrella – whilst this makes little difference if you are caught by IR35, outside of IR35 it means you can’t take advantage of some of the tax flexibility of your own company, and you will be taxed/nic’d as you would have been inside IR35
- Some people don’t like the loss of control
Increasingly if an engagement is caught by IR35 then use of an Umbrella company is made mandatory by the client or agent.
Whitefield Tax do not currently offer an Umbrella company scheme to clients.
An alternative to having your own company used to be a composite company, sometimes known as “managed service companies” or MSCs. From 2006/07 the tax regime for MSCs changed significantly. All MSC arrangements must now be 100% PAYE, with no dividend payments possible. Travel expenses have also been curtailed.
As a result of this their popularity has waned. To all intents and purposes they are a subset of umbrella companies now. We don’t offer any form of MSC.
Over the years a number of hybrid tax schemes, each a differing variation on a theme, have been offered to contractors and freelancers, this included loans schemes and offshore structures.
Almost all of these have been shut down by HMRC. A number of them were built on dubious interpretations of tax law.
As a general principle if something looks too good to be true, then it probably is, and most people are advised to proceed with utmost caution around such arrangements.
Whitefield don’t offer tax planning schemes – our view is a properly run PSC gives tax flexibility and a fair tax result.
The main steps are:
- Registration of your company at Companies House
- Opening a business bank account
- Registering the company with HMRC for Corporation Tax
- Registration with HMRC as an employer
- Registration with HMRC for VAT (if relevant)
Whitefield can take care of most of this – the only thing not covered is a business bank account – as a Company Formation package which costs £120 + vat.
For a business bank account, we recommend for speed and ease you start with a bank who you have an existing private relationship with; there are several other options available in terms of challenger banks though.
Additionally, individuals may need to consider:
- Insurances – Professional Indemnity, Public Liability, All Risks – depending on their circumstances
- Registration with Information Commissioner
- Registration of Domain Names and Website
Some things to think about before starting to register a company:
- Registered office – this is where official tax papers and Companies House papers are sent and is normally your home or your accountants office. We offer a free registered office service to our clients.
- Accounting reference date – this is the company’s year end, although the first “year” may be more or less than 365 days. A year end of 31 March annually is the simplest to use as it ties in with the tax year.
- Directors – these are the individuals responsible for running the company, and there must be at least one, normally the contractor. A director is responsible for running the company on the shareholders behalf, and also has legal responsibilities for making sure the company does not trade whilst insolvent, pays its taxes and files returns and accounts at Companies House and HMRC.
- Company secretary – its no longer compulsory to have a secretary, although many people still do. The company secretary is an administrative role with less responsibility than director.
- Issued share capital – The issued share capital is the number of shares issued – normally 100. The size of the issued capital is more important as it defines the flexibility for nominating share holdings – eg if two shares are in issue then the holdings can only be 50% or 100%, whereas if 100 shares are in issue then there are permeations from 1% to 100%
- Shareholders – these are the owners of the issued shares, and normally will be the same as the directors. Shares can, in theory, be put into the names of family members, but there are pitfalls here, and the situation needs to be reviewed on a case by case basis. Generally it is only worthwhile skewing the allocation of shares if your contract income is outside of IR35.
Once registered, Companies House will issue a Certificate of Incorporation, which is the company birth certificate.
In terms of time scales on forming a company:
- Submission to Companies House – we normally do this same day or next day, and will let you have a company number as soon as we hear back from Companies House. Normally we have the company number within 24-48 hours.
- Completion of file opening – we have a number of formalities to complete, including identification and sending you a comprehensive welcome pack, and where requested dealing with vat registration,, etc – we tailor our advice bespoke to each client to make sure you are setting out on the right foot – allow a week for this, although its normally just a few days.
- Vat registration – this is outside of our hands, allow two weeks, although HMRC are normally quicker. We apply for this online for you.
- Bank accounts – bank account opening is never quick these days due to banks customer identification requirements and bureaucracy. We strongly advise clients to start with their existing bank as that should be the quickest route. The bank account must be in the company name, and can’t be processed until the company is registered at Companies House.
The person forming the company will provide you with the Memorandum and Articles of Association. The Memorandum of Association sets out key facts about the company, and the Articles of Association form the company’s rule book for matters like share transfers, appointment of directors, etc. The Articles of Association are normally based on Table A, which is a standard set of Articles set out in the Companies Act.
Sometimes trade will cease temporarily and you may want to think about pausing activities in your PSC for a while. There are a couple of options:
If the pause is temporary then the company can just be left ticking over for a few months with no major implications – make sure that matters such as VAT and tax payments are attended to though. By law however the company does not qualify as “dormant” at this time.
If the period of inactivity is a bit longer then the company may become dormant. This would not normally be until the end of the financial year after you ceased generating income. A few things to know:
- The company is capable of easy resurrection at the appropriate time.
- Full year end accounts and returns will be needed for the year in which the company becomes dormant and the following year.
- Dormancy can only apply where the company has no significant accounting transactions, which in practice means the bank account must be closed down before the start of the financial year for which dormancy starts.
- Dormancy can only apply to complete financial years, so if you resurrect a company part way through a year it will not be dormant for any part of that year.
If you wish to cease using your company, due to a permanent post, retirement, ill health, etc, then there are two routes to permanently close the company
- Strike off – simple and easy, £10 payment to Companies House, however not tax efficient if residual reserves in the company exceed £25,000 (after all liabilities are cleared, including repayment of directors account and paying Corporation Tax – basically retained profit)
- Members voluntary liquidation – more expensive (about £2,000 upward) and takes longer (3 to 6 months), but more tax efficient for balances over £25,000
The issue here is tax treatment of retained profits – thats to say profits after Corporation Tax has been paid, but which haven’t been declared as dividend. If they are declared as dividend then there is a possibility of Higher Rate Tax at dividend rates. By contrast if they are paid as a Capital Payment then Capital Gains Tax applies, under the following broad criteria:
- Annual CGT exemption of £12.300 per shareholder (2020-21)
- Balance at 10% if qualifying for Entrepreneurs Relief (likely, but check if there are large cash balances or non business assets)
- Balance at 18% / 28% if Entrepreneurs Relief doesn’t apply
The figures really need to be looked at on a case by case basis, but the following broad rules apply:
- If the amount to be distributed could be paid as a dividend inside Basic Rate tax, then thats preferable – if not then:
- If the amount is less than £25k then use the strike off procedure with a Capital Payment liable to CGT
- If the amount is more than £25k then use a Members Voluntary Liquidation to access CGT rates
A couple of points to note:
- The £25k is company wide not per shareholder
- CGT annual exemption is per shareholder
- If a Members Voluntary Liquidation (MVL) is needed then this has to be done by an Insolvency Practitioner (even if the company is solvent).. Costs are likely to be c£1,000 upwards plus the same again in disbursements, £2,000 is a safe estimate.
- HMRC have anti avoidances rules. If you close a company via an MVL, and claim Entrepreneurs Relief, the relief will have to be repaid in full if you start up a similar business within 2 years. It’s worth noting that there is an exception if you can evidence that the transaction is not tax motivated.
Preparing to close
Either way, the route to prepare for closure:
- Raise final invoices to customers, and obtain payment
- Clear all creditors and monies owed, other than taxes
- Apply to HMRC for vat de-registration via your Government Gateway account
- Forward your final quarters/year to date paper work to us
- We will prepare final accounts, and advise tax liabilities thereon
- Settle tax liabilities – they are due immediately, and the application for closure cannot be started until all taxes have been settled
At this point we can proceed with the strike off – see below – or otherwise we hand over the reins to an Insolvency Practitioner if a Members Voluntary Liquidation is being used.
If strike off is the route chosen, then picking up from above, actions are:
- Close business bank account; transfer all funds to private account (it is important this is done as soon as possible after trading ceases – do not leave money in the business account for any longer than necessary). The exception to this is a final period where a loss has occurred, and a corporation tax refund may be due – it may be a good idea to keep the account open in order to accept the refund.
- Submit form DS01 to Companies House with a £10 cheque – this needs to be from your private bank account.
- There is a waiting period of three months under law, and then the company will be struck off unless there have been any objections in the interim.
A few points to note on strike off:
- The DS01 is the last step – people often think its the first, but the process has to be timed properly. Do not apply for strike off before the final accounts are prepared or the bank account closed – you could find your company funds frozen and reverting to the crown, or the strike off being halted by objection from HMRC.
- Bank accounts are frozen on strike off and their contents revert to the crown, so they must be closed after final taxes have been paid.
- Assets such as computers, desks, etc, normally revert to the directors on strike off as their value will be minimal