Back in 1999, when Gordon Brown was Chancellor of the Exchequer, the Inland Revenue released a report that became commonly known as IR35. This report highlighted legislative changes aimed at tax avoidance through the use of personal services companies. The new legislation took effect in April 2000.
The IR35 report pointed out that in addition to other benefits, the individual setting up the PSC may be in a position to be paid dividends by the PSC, as an alternative to only being paid earnings the PSC’s employee, and that this form of income ‘would not be subject to NICs.’
Also, there are benefits to the client of the PSC. ‘They do not incur employer NICs on the payment they make to the PSC.’
To counter this, the IR35 legislation allows the UK tax authorities to LOOK THROUGH a contractual relationship, where services are provided through an intermediary such as a PSC, but the underlying relationship between the worker and the client has the characteristics of EMPLOYMENT.
When this is the case, the tax authorities would treat the engagement as EMPLOYMENT for tax purposes.
The circumstances when Personal Service Company rules apply are:
- A company has a contract to supply services to a client.
- The services are undertaken by an individual.
- If the services were provided under contract between the individual and the client and under these circumstances the individual is regarded as an employee of the client.
- The individual owns at least 5% of the company.
|PROFORMA FOR NOTIONAL SALARY CALCULATION:||£|
|INCOME FROM ENGAGEMENT||X|
|STATUTORY DEDUCTION (5% OF ENGAGEMENT INCOME)||(X)|
|SALARY PAID BY PSC (THIS WOULD ALREADY BE COVERED BY EMPLOYMENT TAX RULES)||(X)|
|EMPLOYER’S NICS PAID BY PSC ON SALARY||(X)|
|PENSION CONTRIBUTIONS OF PSC||(X)|
|DEEMED SALARY INCLUDING NICS THAT WOULD BE PAYABLE BY PSC||X|
|EMPLOYER NICS PAYABLE ON DEEMED SALARY (13.8/113.8)||(X)|
Lily owns 100% of the shares of Monte Carlo Ltd. Personal Service Company (PSC) rules apply to the income of Monte Carlo Ltd. The following financial figures are relevant to the year ended 5th April 2021:
|INCOME GENERATED BY MONTE CARLO LTD||£90,000|
|COSTS OF ADMINISTERING MONTE CARLO LTD||£4,300|
|ANNUAL SALARY PAID TO LILY||£45,000|
|DIVIDEND PAID TO LILY||£12,000|
|CONTRIBUTION PAID INTO OCCUPATIONAL PENSION SCHEME FOR LILY||£5,000|
What would the tax authorities calculate as Lily’s deemed employment income for the tax year 2020/21?
|INCOME GENERATED BY MONTE CARLO LTD||90,000|
|LESS: COSTS OF ADMINISTERING AT 5% OF INCOME (5% x £90,000)||(4,500)|
|LESS: SALARY PAID TO LILY||(45,000)|
|LESS: EMPLOYER CLASS 1 NIC (£45,000- £8,788) * 13.8%||(4,997)|
|LESS: PENSION CONTRIBUTION||(5,000)|
|DEEMED EMPLOYMENT INCOME INCLUDING EMPLOYER CLASS 1 NICS||30,503|
|LESS: EMPLOYER CLASS 1 NIC ON DEEMED EMPLOY. INCOME (£30,503 x (13.8/113.8))||(3,699)|
|DEEMED EMPLOYMENT INCOME||26,804|
NOTE: On Lily’s income tax computation for 2020/21 she would not include the £12,000 dividends. The dividends would be treated as being part of the DEEMED EMPLOYMENT INCOME of £26,804.
NOTE: A flat rate 5% deduction is made for the costs of running a Personal Services Company. Therefore the actual costs of running the company are ignored.
NOTE: Because Lily is the only employee, the £4,000 EMPLOYMENT ALLOWANCE is NOT available.