Personal service companies

HMRC provides guidance on how to determine where IR35 applies

HMRC has for some time been challenging the status of individuals who provide their services through an intermediary or personal service company. These companies are popular with persons who can use them to minimise PAYE and national insurance contributions.

The legislation enabling this challenge is to be found in section 49 Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003), but is commonly referred to as IR35 after the press release when it was first announced. It applies where the worker would be treated as an employee if the company did not exist.

There was some expectation that the Autumn Statement would introduce further legislation to restrict these companies, but the draft legislation is confined to persons operating through an offshore agency, where the necessity for actual ‘personal service’ has been removed and replaced by on obligation for personal service.

It also intends to stop agency workers working through limited companies, which at present is an alternative to the agency deducting PAYE.

HMRC issued a press release in February 2000, listing various tests to indicate employment status. It issued further guidance in May 2012 as Business Entity Tests.

There are 12 tests:

  • Business premises test: does the company operate from premises which are neither the worker’s home nor the client’s premises?
  • Professional indemnity test: does the contractor need PII
  • Efficiency test: has the business had the opportunity in the last two years to increase income by working more efficiently?
  • Assistance test: does the company engage workers other than directors/shareholders/partners who bring in 25% or more of the turnover?
  • Advertising test: has more than £1,200 been spent on advertising in the last 12 months?
  • Previous PAYE test: has the client engaged the worker on PAYE employment terms within the 12 months ended on the last 31 March for the same work?
  • Business plan test: does the business have a business plan?
  • Repair at own expense test: would the company bear the cost of putting right any mistakes?
  • Client risk test: has the company been unable to recover payment for work done in the last 24 months?
  • Billing test: does the company invoice for work carried out before being paid and does the company negotiate payment terms?
  • Right of substitution test: can the company send a substitute?
  • Actual substitution: has the company used a substitute in the last two years? 

Income tax

If the company is caught by the rules, it is necessary to calculate a deemed salary payment; the calculation is prescribed in section 54 ITEPA 2003 as follows:

Income from relevant engagements 100,000
Less 5% deduction -5,000
Travel expenses2,000 
Salary paid12,000 
Employer's NIC (12,000-7,696) @13.8%594 
Gross deemed payment 80,406
Less: Employer's NIC (80,406-7,696) @13.8% -9,750
Net deemed employment payment 70,656

The deemed salary is subject to PAYE and employee’s Class 1 NI.