From April 2017, there will be a significant change to the way in which Personal Service Companies (PSC’s) in the public sector are taxed. Currently, there are over 250,000 PSC’s in Britain, many operating in sectors such as healthcare and IT. Because PSC’s are often structured with just a sole director and shareholder, working often just for one other organisation, the government are fighting to classify them as employees, where PAYE and NIC applies.
Tax planning for PSC’s
Providing services through a limited company can reduce and defer the payment of income tax for the owner, significantly.
This is because corporation tax is calculated at the end of the financial year and payable many months following.
In addition, because of the structure of salary and dividends for PSC directors’, NIC is virtually exempt for most.
PAYE doesn’t usually apply either as the annual salary drawn is in-line with the personal allowance, eliminating any income tax. Therefore, directors are only taxed directly on dividends, for which there are generous allowances.
In April 2000, IR35 rules were introduced to combat perceived tax avoidance of one-man-band PSC’s operating in this way – essentially aiming to eliminate those PSC’s that were contracted with just one other business or organisation.
Practically though, HMRC don’t have the necessary resources to chase PSC’s for breaking IR35 legislation, so consequently little tax of this nature is collected.
All in all, it is logical that the government has disliked this arrangement for a long time now. However, for those PSC directors this decision will prove highly problematic for their tax position.
How it will work from April 2017
The changes, at present, will only affect public sector PSC’s, which includes NHS contractors, Ministry of Defence workers, and a handful of other contractors working with specific organisations, such as the BBC.
From April 2017, if a business chooses to recruit a PSC, then a public body will need to make the decision whether that PSC is generally of self-employed nature, or if the owner of the PSC is simply using this trading structure as a means to avoid paying PAYE and NICs.
The responsibility lies with either the public body or the agency through which the contractor PSC is supplied.
If it is deemed that the PSC should be treated like an employee, the agency or the public body would be required to withhold PAYE and NIC on any payments, and in addition they will become liable to pay Employers NIC.
Implications of this new system
This new system has clear negative effects for PSC’s working in the public sector, which could also affect the pricing that contractors charge to organisations such as the NHS.
Affected contractors will be subject to higher tax bills and may need to revisit their business structure and tax status.
Agencies will also be out-of-pocket if they need to cover additional Employers NIC, and price pressure could also affect their margins. Agents may well choose to steer clear of any PSC that can’t fully demonstrate their independent, self-employed status.
In addition, there is likely to be an increased cost for public sector companies, like the NHS as they may also be required to cover NIC’s, which seems counter productive to wider government objectives.
What about PSC’s in the Private sector?
These rules only apply to the public sector for now, however speculation is such that if the government manage to raise significant revenues from their new system, then how long before they expand it into the private sector as well?
Similarly, private healthcare, IT, business administration and many other sectors that are prevalent in the contracting field could be affected.
For now, the best guidance is to keep informed of any suspected changes.
Seek tax planning advice if you believe you could fall foul of these rules should they be impacted on the private sector too.
This way some planning could take place to ease any transition should it arise.