Personal service companies and IR35

Many individuals undertake work through an intermediary structure such as their own personal service company (PSC). This can be done for a variety of reasons such as limited liability, because the engager insists, or because it can mitigate tax. Without the off-payroll working tax rules, known colloquially as IR35, both the engager and the individual worker could pay less tax and national insurance (NIC).

When an individual undertakes work for another person or business entity, the tax system requires the contract between the engager and the worker, whether real or implied, to be classified as one of either employment or self-employment, and taxed accordingly. IR35 requires this assessment irrespective of the PSC standing in between. Until 2017 the burden for assessing whether IR35 applied to a contract, and then also for paying the tax (PAYE and employee’s and employer’s NIC), was on the PSC.

Changes to the application of IR35 to public sector contracts

From April 2017 rules were introduced to shift the responsibility for deciding whether IR35 applies to a contract, and therefore the payment of tax, from the PSC to the engager when the engager is a public sector body (PSB). If IR35 does apply, the PSB has to pay the PSC through the payroll as if it were a natural person, so deducting the PAYE and employee’s NIC. It must also pay employer’s NIC.

The amount deducted for PAYE and employee’s NIC will reduce the cash received by the PSC on settlement of the invoice.

Private sector contracts are currently unaffected. However, the government has recently published a consultation document to consider extending the new rules to the private sector.

Financial reporting implications

There has been some debate as to whether the PSC’s revenue should be measured ‘gross’ or ‘net’ ie, the amount of the contract fee before or after the PAYE and employee’s NIC has been deducted by the PSB.

Revenue measured ‘gross’

Staff at ICAEW’s Financial Reporting Faculty have had extensive discussions with member firms and regulators about this issue. The clear consensus is that turnover recognised in the PSC’s accounts should be measured at the gross amount, reflecting the contract fee and the value of the work done, which has not changed as a result of the amounts deducted by the PSB in accordance with the new tax rules.

What about the amount deducted by the PSB?

When the gross method is adopted there will be a difference between the turnover recognised and the amount receivable. This difference will not be recoverable by the PSC. The consensus view is that this should be treated as an expense – generally as a staff cost within Administrative Expenses – in the PSC’s accounts, matched by a reduction in the debtor. In our view this staff cost should be recognised in the same accounting period as the contract revenue. Therefore, if the amount that the PSB deducted for PAYE and employee’s NIC is only known after the year end, this would give rise to an adjusting post balance sheet event (debit staff costs and credit debtors).

HMRC have indicated that where this approach is adopted (ie, the PSC’s accounts include ‘gross’ turnover, and an expense representing amounts that are not receivable) the expensed amount will normally represent an allowable tax deduction in computing the PSC’s trade profits.

Further guidance

• Read HMRC’s guidance for accounts of the intermediary PSC
• Read the latest Tax Faculty commentary