Contractors using a limited company

Overview

If your limited company is not supplying goods, but your own personal services – for instance, you are an IT contractor – your company will be a ‘personal service company'. In this situation you will have to consider the impact of the IR35/off payroll working rules. 

These rules are particularly complicated and you would need professional advice if they apply.

It is important to note that the IR35/off payroll working rules only apply where the worker owns more than 5% of the shares in the limited company. 

The IR35 rules

Each time you work for a new person/business (called the end client), the IR35 rules require you to look at the actual working arrangements between you and the end client, ignoring your company. If you would be an employee of the end client you are working for but for the limited company, then: 

• IR35 is likely to apply
• your limited company should tell HMRC
• additional tax may need to be paid. This will usually apply in circumstances where you have received dividend income from your company (as well as or instead of wages/salary) – to make up for the fact that dividends are taxed more favourably than salary. 

There is a tool on GOV.UK to help you determine employment status for tax. You can find an overview of the IR35 rules on GOV.UK.

The April 2017 public sector reforms

In April 2017, HMRC brought in some new rules because they felt that the IR35 rules were not working well. Therefore since April 2017, if a person is working through their own limited company for an end client in the public sector, then they are no longer in charge of deciding if the IR35 rules apply. The decision as to whether the IR35 rules apply now falls to the public body. If they do apply, PAYE tax and National Insurance must be withheld at source on any payments made to the limited company.

The April 2021 private sector reforms

The public sector reforms were extended to the private sector in April 2021, but they only affect workers in limited companies that supply their services to medium and large size businesses. 

If you provide services to ‘small’ clients in the private sector (as well as individuals, for example, homeowners needing an electrician or gardener) through your own limited company, you will still need to consider whether the original IR35 rules apply to you – these did not just fall away altogether post April 2021. 

So you need to make sure you are clear on whether your client is ‘small’ and if so, what the IR35 rules mean for you. GOV.UK guidance for those providing their services to small clients is available here. 

Please note that for ease, we tend to think of and refer to the original rules as IR35 and the 2017/2021 rules as off payroll working, although not everybody demarcates them like this. 

Off-payroll working reforms in more detail

Basically, the 2017 and 2021 rules say that if you look like an employee for the public sector client or medium/large end client that you work for in the private sector, then you should pay tax like an employee. However, because it is only a ‘deemed’ employment relationship, you will not get any of the employment rights that usually go along with being an employee.

This means that the entity responsible (usually the end client or agency) for paying your company will have to operate PAYE tax and National Insurance on the amount they pay to your limited company for your services. You can read more about the requirements on ‘fee-payers’ on GOV.UK.

You should then be able to draw out the money from the company as either a salary or dividends without further deductions. 

The end client that you work for is responsible for deciding whether you look like an employee (and thus, whether they need to operate PAYE), by applying the general ‘status’ tests. Again, there is a tool on GOV.UK to help with this. If they are not the entity responsible for paying your limited company they then need to pass the result on so that PAYE can be operated further down the supply chain, as appropriate. You can read more about the requirements on end-clients on GOV.UK.

If you are a lower-paid worker, you are not likely to have much autonomy over the work that you do for them, so the end client will probably determine that you look like an employee. 

This is really the key difference between the new rules and the original rules. Under the original IR35 rules, the decision as to whether you look like an employee or not rests with your own limited company, whereas under the new rules, the end client makes the decision instead (with consequences for them if they get things wrong). This makes it much more likely that the rules will be applied properly and that everyone will then pay the correct amount of tax and National Insurance in accordance with the law. 

You can find a summary of the rules as they apply to workers who are providing services to the public sector or medium and large clients in the private sector on GOV.UK. HMRC’s technical guidance can be found here.

Given the potential complexity, there are some extra resources available to help workers understand the rules, including flowcharts, case studies and factsheets on GOV.UK. Webinars and videos are also available. 

If you stop using a limited company

If the off payroll working rules apply to you, any cost savings there used to be may have disappeared. So, working through a limited company becomes much less attractive, especially when you consider all the admin that usually goes with running a limited company. 

Therefore, you may wish to, or be asked to, stop working through your own limited company. Your options are then to: 

• try and get taken on directly by the end client as an employee
• carry on working ‘flexibly’, via an agency for example, but under PAYE 
• work through an umbrella company. If you are asked to work through an umbrella company, it is important to understand the risks – we recommend you read our guidance.

If you stop working through your own limited company, you may need to take steps to ensure that it is closed down properly.

Managed service companies

In the past, managed service companies (MSCs) have been used to try to help workers avoid reaching the 5% shareholding threshold required to trigger the IR35/off-payroll working rules. This was at same time as offering, on the face of it, similar advantages to working through a limited company. 

Broadly, workers would own shares in a composite company – made up of many, generally unconnected (apart from perhaps being in the same type of trade), non-director shareholders, each holding different classes of share. This would allow the appropriate amount of income to be channelled to them via a dividend.

However these structures now fall under the managed service company legislation. This requires managed service companies to apply PAYE to all income received through them, as it deems any payment or benefit received by a worker to be earnings from employment. The nature of the relationship between the worker and the end client does not matter in this situation, as it does for IR35/off-payroll working rules. 

These rules are also very important to know about if you work through an agency or umbrella company where a limited company has been set up for you to work through and where someone helps you run the limited company, for example by deciding a strategy for you on how to be paid or by doing all the admin for you. 

This is because they may be a managed service company ‘provider’, which, means that the limited company you work through could be a managed service company (even if it is not a composite company). As such, PAYE should be applied to all income you earn though the company. Some more information about this scenario is set out in HMRC’s Spotlight 32 on GOV.UK.

Although HMRC are actively investigating some situations where they think limited companies are managed service companies, until now there has been very little guidance designed for workers. Due to the risks, this has now changed. If you are an agency or umbrella worker and operate through a limited company, it is important to read HMRC’s more recent Spotlight 67 in full and understand if you think you might fall within the managed service company rules. 

It is important to understand that the managed service company rules are different to the IR35/off-payroll rules that can also apply to limited companies. Indeed, even if you are outside IR35/off-payroll, you can fall within the managed service company rules.