New legislation that goes live this April could be the death knell for many personal service companies active in the North-east of Scotland, but perhaps offers an opportunity to plan ahead for some.
The change in law is going to have a major impact on the owner of a personal service company, which with reference to the oil and gas sector, is typically a business that comprises one person working as an employee in everything but name.
There are thousands of people running personal service companies in the north-east who clock in at work like an employee, use electricity and other office services like an employee, but pay tax like a business. This is often referred to as off-payroll working, or IR35, and has been a feature of business life for many years.
At the moment, personal service companies do not have to factor income tax or national insurance into hourly/daily rates charged. However, with the IR35 change in April this year placing the onus on the employing entity to decide if the person providing the work through a personal service company is to all normal measurements an employee, there is a clear risk to the personal service company that it will be contracted (and treated for tax purposes) as an employee rather than an independent company.
Large oil and gas companies in the north-east may well decide to implement changes to their engagement/payment structure and seek to avoid the potential risk of being assessed for tax deductions by HMRC after having paid personal service companies gross. Indeed, many have already stated this intention.
HMRC wish to distinguish between those who genuinely work for many different clients from those who use a personal service company to avoid paying the higher rate of tax that would arise as an employee doing the same job.
One way that personal service companies may wish to minimise the impact of the legislation on earnings to date and retained in the company is by being subject to a solvent liquidation process and allowing the shareholders to gain access to such a pot of money at a reduced rate of tax. Currently a solvent liquidation allows shareholders to extract cash in a more tax-efficient manner i.e. having it taxed as a capital gain (maximum rate is 20%) rather than dividends or salary (maximum rate is 46%). Further, if entrepreneur’s relief is available to a personal service company’s shareholders, the capital gains tax rate is reduced to 10%.
There will always be those who seek a way around all this and act as if nothing has happened. For example, some may consider becoming part of an umbrella company as a way of attempting to mask that they might be considered an employee. That might be quite a brave route, even if the principal employer accepts self-employed status, because it could still leave the tax status open to challenge from HMRC. Worse, if the personal service company’s assessment is incorrect, HMRC might decide to look at earlier years and thereby compound a potential tax charge on the personal service company.
A very recent government announcement referred to an emergency review of the IR35 rules lest there are personal service company arrangements that fall foul of the forthcoming changes unfairly and don’t determine employment/self-employment status correctly.
Whether the review produces changes to the law within the next few months is a matter of conjecture and all eyes will be on the Chancellor’s Budget this March for any change to the definition/availability of entrepreneur’s relief.
Going forward, it seems likely that there will be a decline in the number of personal service companies in the North-east and as a result more tax-paying employees. Some will see this as levelling the playing field.