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How does HMRC define a ‘personal service company’? Here's what you need to know for IR35

2-minute read

How does HMRC define a ‘personal service company’? Here's what you need to know for IR35
Lauren Hellicar

Lauren Hellicar

4 February 2020

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HMRC created the term ‘personal service company’ (PSC) after Gordon Brown, then Chancellor of the Exchequer, brought in the IR35 legislation in April 2000.

But what does it really mean to form a personal service company?

  • Government’s IR35 review is 'disappointingly hasty and inadequate'
  • What is IR35? A guide for the self-employed
  • Contractors told to go on the payroll or quit: how big business is responding to upcoming IR35 changes
  • Is business insurance a legal requirement?

What’s the legal definition of a personal service company?

Personal service companies are limited companies, which are usually set up as one-man bands. They tend to provide the services of one contractor, who’s often the company’s only shareholder and sole director.

Unfortunately there’s no legal definition of the term, and HMRC has been accused of using this to its advantage when carrying out tax investigations.

Why should I set up a personal service company?

Setting up a personal service company isn’t a choice for many contractors. Usually it’ll be their clients who demand that they manage themselves in this way. If they want the work, they’ll need to set up using this business model.

From a tax perspective, however, being a limited company can be an efficient way to operate. Contractors with PSCs usually pay themselves using a mixture of salary and dividends.

They don’t pay things like employers’ or employees’ Class 1 National Insurance contributions and end up with a higher take-home pay.

How does it benefit the end client?

Clients like to work this way to avoid having an employer-employee relationship with the contractor working for them. Recruiting employees comes with expense and hassle the client organisation often doesn’t want to deal with, especially for one-off projects.

Hiring an individual who’s a limited company is also a way to reduce the risk to the hiring organisation. For example, they have the option to sue the contractor if things go wrong.

To add an extra layer of protection and flexibility, the hiring organisation may use an agency. Agencies are like a one-stop shop for a business looking for contractors with specific skills to work on an as-needed or project-by-project basis.

What does HMRC think of PSCs?

HMRC is clamping down on the use of PSCs by way of the IR35 legislation. The rules are aimed at contractors who would be classed as employees if they were providing their services directly to the hiring organisation.

The tax authority is trying to make sure these individuals pay the same tax and National Insurance contributions as employees. However, this fails to take account of the fact that contractors don’t receive employee benefits like sick pay, holiday pay and maternity and paternity pay.

Read more about what happens if you’re inside IR35.

How do I set up a personal service company?

Setting up a personal service company is just like setting up a limited company. You can read more about how to do this in our guide to starting a limited company in the UK.

We’ve also got tips on registering with Companies House and changing from a sole trader to a limited company.

Do you operate as a personal service company? Was it your choice to set up in this way? Let us know in the comments section.

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