Where are we now with personal service companies?

By Tolley

The following Owner-Managed Businesses guidance note by Tolley provides comprehensive and up to date tax information covering:

  • Where are we now with personal service companies?
  • Introduction
  • Uncertainty
  • Unfairness
  • HMRC investigations
  • Application to office holders
  • Improvements in HMRC guidance and administration
  • Intermediaries and public sector bodies
  • What next?


The IR35 legislation was introduced over 15 years ago, but it remains problematic. In particular:

  • it is often far from clear whether an individual’s engagements are within, or outside, the rules (see the Employed or self-employed guidance note). This causes uncertainty for individuals, who frequently need specialist advice.
  • HMRC investigations are burdensome and can be financially crippling
  • the regime is unfair because it treats those within scope of the rules as quasi-employees but without giving them employment rights. As a result, those affected by the regime have long campaigned for its abolition.

Each of these is discussed briefly below.


The rules are conceptually simple. They ask only one question: “would the worker have been employed by his client if there were no intermediate company?” (see the Introduction to personal service companies guidance note).

If the answer is yes, the engagement falls within the rules and the worker’s company has either to account for NIC and PAYE on deemed salary, or pay the same amount as salary during the tax year (see the Calculating the deemed employment payment guidance note).

Establishing the answer to the simple question posed by these rules is, however, very difficult. There are no clear definitions of employment and self-employment; instead, the tests derive from numerous employment, tax and negligence cases, and are thus subject to adjustment as new decisions emerge from the courts (see the Employed or self-employed guidance note).

This complexity creates a huge grey area either side of the employee / self-employed line. HMRC has published extensive guidance but this, of course, is not the law.


HMRC has also taken a succession of cases through the courts, but as each case is decided on its own facts, these provide limited help for individuals seeking to establish its own position. Recent cases include (all links subscription sensitive):

  • MCDM Ltd v HMRC [2018] UKFTT 201 (TC)
  • Big Bad Wolff Ltd v HMRC [2017] UKFTT 729 (TC)
  • Novasoft Ltd v HMRC [2010] UKFTT 150 (TC)
  • Dragonfly Consultancy Ltd v HMRC [2008] STC 3030
  • Alternative Book Co Ltd v HMRC [2008] SSCD 830

Another problem that besets these rules is unfairness. The original press release  which introduced the original legislation in 1999 said the rules were needed because service company structures had damaging social consequences. Individuals working through service companies:

“may find their terms and conditions altered – perhaps losing entitlement to sick pay or maternity leave. They may even lose their jobs without entitlement to notice or redundancy pay. They will usually have no right to any claim for unfair dismissal and may lose their entitlement to social security benefits through a failure to make adequate contributions.”

However, IR35 did nothing to redeem this situation. It deducts employee’s and employer’s NICs from the workers’ deemed salary, because the individuals are deemed to be ‘disguised employees’ of their clients. But employment law does not recognise this status. The individuals cannot claim unfair dismissal if their engagement is terminated, they have no rights to statutory redundancy, and cannot normally obtain Jobseeker’s allowance.

HMRC investigations

All those subjected to an HMRC enquiry are likely to suffer stress. In the case of intermediaries legislation this is compounded by two factors.

First, the money involved in a successful investigation can be significant. HMRC will seek to collect employer and employee NICs on all engagements within the scope of the rules during the last six years. These sums can bankrupt a small business, and the threat of such a heavy financial sanction is bound to have a damaging effect.

Second, most tax investigations are relatively private affairs, involving HMRC, taxpayers and their advisers. But the intermediary rules are different ― in order to establish whether an engagement is within or outside the legislation, HMRC frequently makes contact with the service company’s clients. See the Implications for intermediaries guidance note for more information.

Tangling with the taxman is not popular with any business, and this HMRC intervention may harm the relationship between the service company and the client ― even if the engagement is, after enquiry, found to be outside the scope of the rules.

Application to office holders

Just as the first stages of HMRC’s improved guidance and administration outlined above were bedding in, the scope of IR35 was expanded to include office-holders, an extension not covered in any depth in the guidance. The extension to office holders took place in FA 2013, s 22 with effect for 2013/14 onwards.

Improvements in HMRC guidance and administration

As mentioned above, those affected by the regime have long campaigned for its abolition. There was a brief ray of hope offered when the coalition Government promised to review IR35 and replace it by simpler, less burdensome measures. In practice, what happened was that the Government referred the issue to the Office for Tax Simplification (OTS), which considered it as part of its Small business tax review . It made two recommendations pending more considered structural changes. These were:

  • to suspend IR35 with the intention of permanent abolition
  • to keep IR35 unchanged, but improve HMRC’s administration

The Government opted for the latter of these recommendations, and was not inclined to take any more radical action to reform IR35 at that time.

Following on from the OTS recommendation that HMRC should improve the administration of IR35 HMRC has, with the help of the IR35 Forum , introduced a number of measures:

  • new, improved guidance
  • a confidential helpline service
  • a contract review service

The improved guidance included the publication of ‘business entity tests’ (BETs) designed to help taxpayers determine the risk of an IR35 challenge from HMRC. However, these tests were short-lived. They were introduced in May 2012, but by July 2014, the IR35 Forum had come to the conclusion that the BETs were not generally known about or used and that there was evidence of misuse by those who did know about them. The Forum recommended that they be withdrawn, HMRC accepted the recommendation and BETs were abolished as from 6 April 2015.

By this time, the IR35 Forum had published the final report of its Administration Review . Aside from the formal recommendation that BETs be withdrawn, that review made a number of detailed recommendations around promotion and communication of the regime, improvements to the helpline and contract review services and the way in which HMRC conducts IR35 enquiries.

Since March 2017, HMRC has operated a new IR35 test called the ‘check employment status for tax’ (CEST). This online service uses a number of simple questions to determine whether the worker would be deemed to be an employee.

Check employment status for tax 

It should be remembered that the answers given must reflect what happens in practice, rather than what is strictly said in any of the contracts in place. For this reason, HMRC provides two key caveats to a CEST result. It will not stand by the result if the information given proves to be inaccurate or if there are contrived arrangements designed to achieve a particular outcome.

CEST initially seems to be useful in that it may provide some businesses with certainty that IR35 does not apply. However, there have been a number of complaints regarding the tool, stating that it is not suitable for purpose and does not accurately reflect case law. The suggestion is that CEST is biased towards finding that a worker would be considered to be an employee. Furthermore, there has been criticism concerning HMRC’s caveats regarding results and suggestions that they effectively render any CEST finding that the worker is not an employee as useless.

For more on HMRC’s administration generally, see the Risk assessment for IR35 legislation guidance note (subscription sensitive).

Intermediaries and public sector bodies

With effect from 6 April 2017, if a worker provides services to a public sector body via a personal services company (whether a PSC or a managed service company (MSC)), neither the IR35 rules not the MSC rules apply. Instead, it is up to the public sector body to consider whether the worker would be an employee or office holder if engaged directly. If the public sector body considers that he would be, then a direct payment of employment income is deemed to be made to the worker, either by the public body itself or by any procurement agency or other intermediary which the public sector body may use to deal with the service company and pay amounts due to it. The tax and primary NIC accounted for to HMRC is deducted from the payments made to the service company. See the Intermediaries and the public sector guidance note.

What next?

It was widely reported that the regime for service companies and the public sector caused significant administrative, compliance and cashflow issues for all concerned. However, HMRC has published the findings of independent research into the impact of the changes. On the back of this, it has suggested that reports regarding administrative burdens, costs for contracting bodies and recruitment are rumours, and that public bodies have now adapted to the rules.

Off-payroll reform in the Public Sector 

This research was published alongside the launching of a consultation into future reform of the intermediaries legislation in the private sector. Although the government has stated that it is not necessarily going to extend the public sector regime into the private sector, it did say that it considers that rules around ‘off-payroll working’ are ‘likely to require reform.’

Off-payroll working in the private sector 

Without a more fundamental change to the intermediaries rules, the public sector regime and any future private sector regime will maintain, if not magnify, the uncertainty created by the case law test for employment status.

No announcements are anticipated until after the current consultation closes on 10 August 2018.