One way in which an individual might seek to avoid being classed as an employee is to form a limited company (A personal service company) and then to hire out his or her services in the name of that company. A personal service company applies to consultants, chefs or individuals supplying a trade or a profession. This would enable the individual to exploit the tax and National insurance advantages offered by corporate status and trading as a limited company. However, anti-avoidance legislation (the “IR35” legislation) exists to thwart this kind of disguised employment. The main features of this legislation are as follow:
- The IR35 legislation applies to “relevant engagements” where a worker provides services to a client through an intermediary (usually a company) in circumstances such that the income arising from the engagement would have been treated as income from employment if it had not been for the presence of the intermediary.
- If an intermediary receives income from relevant engagements during a tax year and this income (Less allowable expenses) is greater than the workers employment income from the intermediary in that year, then the excess is treated as a deemed salary payment made on the last day of the year. This deemed payment is subject to both income tax and national insurance contributions, collected via PAYE.
- The allowable expenses referred to above include all expenses generally allowable against employment income, plus any employers’ pension and National Insurance contributions made by the intermediary, plus a further flat-rate 5% of the income arising from relevant engagements (to cover running costs of the intermediary).
- To the extent that the deemed salary is paid out to the worker as a dividend, the intermediary may claim that the dividend should not be liable to tax.
If an individual has a contract with an agency, under which the individual renders services to a client, and these services are subject to “supervision, direction or control” by any person, the worker will generally be treated as an employee. Anti-avoidance legislation exists to prevent agency workers being used to disguised employment as self-employment.
MANAGED SERVICE COMPANIES (UMBRELLA COMPANIES)
Salford Chartered Accountants do not condone the use of umbrella companies. We are of the opinion they are an artificial tax vehicle usually set up by or in conjunction with Employment agencies. We concur they not only try to exploit the tax system (HMRC has introduced strict compliance laws to counter this) however more importantly the fees and charges implemented on individual contractors by many firms operating umbrella companies are extreme and completely out of context. Manged service companies (MSC’s) are like personal service companies in that they act as intermediaries through which the services of workers are provided to end clients. However, whilst a personal service company is usually controlled by the individual who formed it, as MSC is a mass-marketed service company set up and controlled by an MSC provider. Several workers (typically ten to twenty) may become shareholders in an MSC, which then offers their services to clients. Anti-Avoidance legislation has been introduced to ensure that income received by individuals who provide their services through Umbrella Companies is treated as employment income for tax purposes. Umbrella companies are required to operate the PAYE Scheme to collect income tax and National Insurance contributions in relation to such income.
Importantly, no expenses may be offset against employment income.