What is a personal service company and how do they work?

If you are working as an independent contractor, you may find advantages in establishing a personal service company. These entities are typically owned by contractors and are used to provide specialized professional services to clients. When you establish a personal service company, you assume the responsibility of calculating the amount owed to HM Revenue and Customs (HMRC) and filing annual tax returns. In this article, we will address the question of “What is a personal service company?” and elucidate the operational mechanics of these companies, along with outlining the benefits of their formation.

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What constitutes a personal service company?
To answer the query “What is a personal service company?” it’s important to comprehend its fundamental functions and legal status. Personal service companies are limited companies that are established by individual contractors who serve as the sole shareholder and company director. By forming this type of business, you can typically mitigate income tax and National Insurance contributions, with tax only levied on your profits. An exception to this rule applies to contractors who primarily work for a single organisation. As of September 2022, the Finance Act 2000 stipulates that these contractors are required to pay both taxes to prevent unfair tax avoidance.

How do personal service companies function?

The following section offers four informative points that elucidate the operational dynamics of personal service companies:

1. Taxation Procedures:
As independent contractors, owners of personal service companies must submit annual tax returns to HMRC, detailing their business expenses, revenues, and profits. You are subject to corporation tax on your profits, with the exact rate and amount varying based on your profit levels. Additionally, you may be liable to pay tax on dividends exceeding the dividend allowance, and if your income surpasses £85,000, you may be subject to VAT.

If your company provides services to a single client for an extended duration, you might be required to pay income tax and National Insurance contributions on your earnings. The IR35 off-payroll working regulations treat your company as an intermediary that offers your services to clients. Under these regulations, you are obligated to pay personal tax contributions similar to those of full-time employees, although you can claim certain expenses as tax deductions.

2. Earnings and Scheduling:
Since contractors work for themselves rather than for employers, they are responsible for managing their income by setting salaries or taking quarterly dividends. You may negotiate fixed hourly or project rates with clients before commencing work, though you do not have entitlement to paid leave. Depending on your profession, you might also utilize business revenue to purchase capital equipment, offsetting these expenses against your tax obligations. As a company owner, you have greater flexibility in determining work schedules and accommodating other commitments, such as childcare or medical appointments.

3. Registration Process:
To establish a personal service company, you can register a private limited company with Companies House, incurring a cost of £12. You can then select your company’s name, ensuring its availability and legality in accordance with Companies House guidelines. After registering yourself as the sole director and shareholder of the company, you can submit the “memorandum of association” and “articles of association” documents. The former is a signed legal statement acknowledging the formation of the business, while the latter outlines the operational rules of the company. It is advisable to review Companies House’s record-keeping requirements prior to completing the registration process.

4. Business Liability:
As an independent legal entity, the personal service company assumes responsibility for repaying any liabilities, such as debt repayments or supply expenses. If the company fails to meet its obligations, you typically avoid personal liability for making these repayments. In such a scenario, creditors can issue a winding-up petition to dissolve the company and liquidate its assets to settle the debts. However, under certain circumstances, personal liability may extend to the company’s debts. For instance, if you continue to conduct business despite the company’s insolvency, you could be held personally liable for neglecting your duties as a director.

Advantages of Establishing Personal Service Companies:

There are six ways in which independent contractors can benefit from creating personal service companies:

1. Quick Access to High-Paying Work:
One of the advantages of forming these companies is that contractors may find it easier to secure new work opportunities. Since employers can avoid expenses related to pensions and paid leave, you can negotiate straightforward fixed hourly or project rates for your services. This simplifies the negotiation process and allows you to swiftly shift your focus to signing contracts and commencing service delivery. Furthermore, clients may offer higher hourly rates compared to those received by employees, taking into account your operating costs, experience, and absence of contractual benefits.

2. Offsetting Tax Obligations:
Another advantage of this employment model is that you can offset your business’s operating costs against your taxes, reducing your annual contributions. As a company director, you can itemize expenses before determining their direct relevance to business operations. For example, you may assess the value of new capital equipment and office rent before deducting these costs from your tax payments. However, it’s important to note that home rent or mortgage expenses cannot be claimed as deductible expenses, even if you work from home. By offsetting operating expenses, you can increase your take-home income, making it easier to manage household budgets and private pensions.

3. Establishing a Professional Image:
Since self-employed individuals often operate as sole traders, establishing a personal service company allows you to create a distinct and more professional personal brand. By issuing formal articles of association that delineate your operational rules, you can build a reputation within your industry as a reliable and highly skilled contractor. This credibility can instill trust in clients, leading them to entrust you with complex projects of high quality. Leveraging this reputation can set you apart from competitors and potentially attract new or repeat clients.

4. Facilitating Business Expansion:
If your personal service company experiences consistent financial growth, you may decide to expand your services to serve a broader clientele. In such a situation, you can scale up the company without altering its legal structure, as private limited companies can accommodate new employees or shareholders. To pursue business expansion, you can amend the company’s records with Companies House by adding new directors or shareholders. You can also register as an employer by enrolling the company for Pay as you Earn (PAYE) with HMRC and selecting suitable payroll software. This process allows you to expand your business operations without dissolving and reestablishing the existing company.

5. Separating Personal and Business Finances:
As the owner of a private limited company, you are legally required to establish a business-specific bank account. This account manages all financial transactions, including weekly salaries, tax payments, and equipment costs. Separating personal and business finances makes it easier to monitor operational expenses, record recurring transactions for tax purposes, and detect potential fraudulent activities. Using an official bank account for transactions can also reassure new clients that you are a reputable professional who can be trusted to adhere to service-level agreements.

6. Enhancing Work-Life Balance:
Delivering services through a personal service company can also improve your work-life balance, as it grants you greater control over your work schedule. While some clients may expect contractors to work during their business hours, you can negotiate flexibility within this time frame and choose projects based on your preferred hours. If you have already committed to multiple projects, you can decline additional work to avoid excessive working hours each week. Regulating your personal schedule enables you to allocate more time to family activities or hobbies without sacrificing valuable income.

Examples of Personal Service Companies

Two illustrative examples of personal service companies include:

1. Independent Hairdresser:
An independent hairdresser serves as a prime example of a personal service company. These professionals offer hair styling, cutting, and conditioning services to local clients, often in their own homes. Since hairdressers typically cater to a diverse clientele, they may not be subject to HMRC’s IR35 off-payroll working regulations and may only pay tax on their profits or dividends. Independent hairdressers who serve clients in their own homes cannot claim housing expenses as tax-deductible costs, but mobile hairdressers can seek reimbursement for transportation expenses. Additionally, they may reduce their tax liability by deducting hairdressing tool expenses, such as curling irons or shears.

2. Independent Graphic Designer:
Independent graphic designers often undertake projects for multiple clients simultaneously. They determine fixed rates based on the complexity of each project. For instance, they might charge lower fees for designing simple logos and higher rates for revamping extensive e-commerce websites. Graphic design software can be claimed as a tax-deductible expense, although only electronic devices used for work purposes are eligible for such deductions.

While most projects have set deadlines, designers may choose to complete their work outside conventional office hours, provided it aligns with their schedules. Designers who handle ongoing or large-scale projects for a single organization may also be subject to income tax and National Insurance contributions under the IR35 off-payroll working regulations.