Many individuals form a company through which they operate.
The company invoices the end client for work done by the individual and then the individual extracts profit from their ‘intermediary company’ by way of low salary, high dividend, with the dividend often being shared between shareholding spouses.
However, where the individual, or his family, control more than 5% of the company then the personal service company regime needs to be considered.
To decide whether this regime applies, the individual needs to ignore the intermediary company and ask whether their relationship with the end customer is one of an employee or office holder? If it is, then any income from relevant engagements not paid out as salary is treated as a “deemed salary”. This deemed salary is treated as if paid out as salary to the individual on 5 April with PAYE and NIC falling due. The net effect of the rules is to reclassify dividend as salary thus reducing the savings from the intended low salary, high dividend extraction route.
Deemed salary calculation
The calculation of deemed salary is done at the end of the tax year as follows:
|Income from relevant engagements (invoices where employee/ office holder relationship exists)||A|
|Less: 5% automatic deduction||(B) C|
|Less: Expenses paid by employer allowable as deductions from earnings if paid by an employee||(D)|
|Less: Employer pension contributions||(E)|
|Less: Employers NIC on workers actual salary and benefits (Class 1 and 1A)||(F)|
|Less: Actual salary and benefits paid||(G)|
|Gross deemed payment||H|
|Less: Employers NIC on gross payment (H × 13.8/113.8)||(I)|
|Net deemed payment (Deemed gross salary)||J|
Points to note
Remember it is only the income from relevant engagements that are included in the net deemed salary calculation, so only where the employee/ office holder relationship exists. This income is subject to PAYE and national insurance that must be paid over to HMRC no later than 19 April, or 22 April if the payment is made electronically.
It is possible to make a provisional PAYE/ NI payment with any adjustments being reported via an Earlier Year Update submitted electronically to HMRC before the following 31 January.
Unfortunately, the £2,000 employment allowance is not available against the deemed salary secondary NIC.
Corporation tax implications for the intermediary company
All income invoiced will form part of the company’s taxable profits while the deemed gross payment, plus employers NI, is deductible in arriving at the intermediary company’s taxable profits. Deduction is allowed in the period in which the deemed payment is treated as made so, for a company with a 31 December year-end, the 5 April 2016 deemed payment is deductible in the year to 31 December 2016.
If dividends are paid, then there is a risk of double counting the income as both salary and dividends. If dividends are paid then the intermediary company needs to make a claim to set the deemed payments against the dividends paid (ITEPA 2003 s.58). If you are caught by the personal service company rules, it is much easier to stop drawing the dividends and take a salary instead.
With effect from 6 April 2016, measures will be introduced which restrict the ability of certain temporary workers to claim relief from tax and National Insurance Contributions on expenses incurred in relation to home-to-work commuting. The intention is to ensure that such workers are subject to the established principle that relief is not applicable to travel between a worker’s home and his/her permanent workplace (as opposed to a temporary workplace, where relief is available).
New ITEPA 2003 s 339A is to provide that, in the case of workers who personally provide their skills or labour through an “employment intermediary” (broadly an umbrella company, recruitment agency or employment business), each engagement is to be regarded as a separate employment for the purpose of the travel and subsistence expenses rules, so that each workplace will be treated as a permanent workplace. Thus, daily commuting by such workers will be regarded as ordinary home-to-work commuting and will not qualify for relief.
The measure does not, however, apply to a worker whose services are not subject to supervision, direction or control by another person.
The measure also applies to a worker operating through a personal service company which is required to operate the so-called IR35 legislation under contracts where a deemed employment payment is made, or would be made were the worker not receiving all his/her income in the form of employment income. The “supervision, direction or control” provision does not apply in such cases.
So the key is to make sure that you are not caught by IR35 by ensuring that contracts are drawn up carefully, containing the key characteristics of self-employment, especially an effective substitution clause.
Dean Wootten FCA CTA is a chartered accountant responsible for the tax and CPD update service for Tolley Seminars.