How does HMRC define a ‘personal service company’?

What’s the personal service company definition?

Personal service companies are limited companies that are usually set up to provide the services of one contractor. This contractor is 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?

When it comes to contracting, many clients and agencies prefer to work with companies rather than individuals (sole traders). That’s because, even when hiring sole traders on short contracts, the relationship may point towards employer and employee, rather than client and contractor. The client could then be liable for employment benefits like holiday and sick pay.

This means that setting up a personal service company is the only choice for many contractors. If they want the work, they’ll need to set up using this business model.

But working in this way has its benefits for contractors, because it’s often a tax 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 can end up with a higher take-home pay, depending on whether they’re inside or outside IR35.

Working through a limited company also means that your business is a separate legal entity. Read more about the difference between sole traders vs limited companies.

How do personal service companies 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.

The relationship between a personal service company, HMRC, and IR35

HMRC has designed the IR35 legislation to make sure that contractors working through their personal service company aren’t working as ‘disguised’ employees.

To this end, HMRC wants to see that contractors are ‘genuinely’ self-employed – for example, they’re taking on all the risks of running a business, and are providing services on a project-by-project basis (rather than mutuality of obligation existing).

To read more about the tests HMRC may use to work out your employment status for tax, use our IR35 checklist.

Ultimately, if HMRC believes that a contractor would be classed as an employee were it not for their personal service company, that contractor is caught by IR35. HMRC wants these individuals to pay the same tax and National Insurance contributions as employees.

IR35 rules have proven controversial, though. Firstly, they’re complicated, and contractors caught inside IR35 aren’t always entitled to 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.

Useful guides for freelancers

• Being inside IR35 and outside IR35, what does it mean?
• What is IR35? A guide for the self-employed
• What is mutuality of obligation (MOO)?
• Is business insurance a legal requirement?

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.