Several MPs have been accused of using personal service companies (PSCs) to avoid paying tax on second jobs and consultancy work. This is because PSCs can be open to abuse, and in the past many people have set them up purely to pay less tax. But is this really what’s happening here, or is the use of a PSC legitimate in some circumstances?
A PCS is simply a limited company where the main shareholder is also a director, and the company sells that director’s services to others. Thus, it is the company that receives the income and pays corporate tax as opposed to the individual receiving the funds directly. With corporate tax rates being much lower than personal tax rates, this could create an opportunity for those who should be classed as employees to avoid paying income tax and national insurance by becoming a PSC.
HMRC first introduced legislation to tackle the abuse of PSCs back in 2000. The rules, known as IR35, have been tightened up since, most recently in April this year. Broadly, where a PSC provides the services of its director to a third party ‘buyer’, either the buyer or the PSC is required to determine whether the IR35 rules apply. If they do, the income must be taxed under PAYE as if the PSC did not exist.
There are legitimate cases where work undertaken by a PSC does not fall within IR35. This is generally where the job would be treated as self-employment if undertaken personally, and there are specific criteria which can be looked at to determine whether a particular job should be classed as an employment relationship or not. These include looking at:
- who decides what work needs to be done;
- when where and how it will be done; and
- who suffers financial risk if things go wrong.
The effect of IR35 is that being paid by a PSC should only stop PAYE applying if there is genuinely no employment relationship. It is rightly not possible to escape employment tax charges just by calling yourself a company, but if a PSC genuinely provides independent services then it is taxed like any other company would be.
The PSC will pay 19 per cent corporation tax on its profits. For the shareholder to make use of that money, it has to be paid out either as salary or as a dividend. A salary will attract income tax and NIC under PAYE so the profit of the company will generally be paid out as a dividend, which is taxed at a substantially lower rate. But remember, corporation tax has already been paid on the profits the PSC can distribute. Overall, although cash extracted from a PSC is likely to suffer less tax than earnings would, the difference is generally small, especially after the company’s running costs are taken into account.
It would be great if everything in life was black and white, but it isn’t. Can PSCs be used to save tax? Definitely. Are all PSCs used that way? Definitely not. Are MPs misusing PSCs? I don’t know. Public scrutiny of this area is a good thing, but let’s not rush to judgement without the facts.