There are two main potential tax problems with personal service companies, both of which have been fairly well publicised:-
For several years now, the Inland Revenue have been trying to argue that if you undertake most, if not all of your work for a single customer, then your company would be caught by legislation known as IR35. This provides that you would have to pay all of your income from the company in the form of salary which would negate most of the advantages of using a limited company, the principal one of which is to pay yourself as dividends rather than as salary. However, IR35 in practice has proved to be something of a “damp squib” and to date, we have never had any of our clients caught by the legislation. The answer is to ensure that you work under the terms of a written contract with your end customer and that the contract should be between your customer and your limited company and should make no reference to your own name. If your customer asks that your name be mentioned as a consultant, then you need to have what is known as a “substitution clause” i.e. your limited company provides the services of yourself, or such other consultant who may from time to time be agreed between your limited company and your customer, such consent not to be unreasonably withheld. There are numerous examples of standard wording on the Internet which can be used but as part of our routine service, we will generally check your contract to ensure that it is “IR35 friendly”. We would ask that you let us have a copy of any contract that you undertake in order that we can advise you accordingly.
Section 660 (Arctic Systems)
One of the big advantages of trading as a limited company is the possibility to split income with a spouse or partner. If for instance your partner earns £20,000 per year and you expect to earn £50,000 per year, then it would make sense to allocate some of the shares in the limited company to your partner so as to make use of his or her basic rate tax band. The Inland Revenue have sought to challenge this in a legal case known as Arctic Systems Limited. However, this has recently been decided in the favour of the taxpayer in a House of Lords Judgement which means that at present, the Inland Revenue cannot challenge the arrangement although they have said that they may review the situation in due course.