Many freelancers and contractors are attracted to the idea of an Umbrella Company to maximise their earnings. But the Personal Service Company can achieve the same tax advantage, plus you can benefit from lower monthly administration costs and other benefits described below.
For example, as a freelance journalist you will receive an income probably from a small number of clients, and possibly only one. The umbrella company will pay you a salary up the national insurance threshold, reimburse you with any direct expenses and they will pay any remaining balance from the remaining income as a dividend.
The personal service company ( Jargon Busting ) can operate in the same manner in that you can achieve the same salary, up to the national insurance threshold and you can take dividend. The main difference is that the dividend that you can take is based on your estimated profit for your financial year, rather than just the period you have worked.
In the personal service company the director will have a loan account, which following HMRC rules must not be overdrawn (debtor in the company’s accounts) at the end of your financial accounting period and technically at the end of the fiscal tax year 5th April. Therefore if your income varies during the year, due to holidays or other seasonal factors, then as long as there is cash in the business, you can temporarily overdraw your account.
A personal service company can register for VAT. So as long as your clients can recover VAT there should be no impact on your business and the additional charge will improve your cash flow. Under a standard registration you will be able to recover VAT on your purchases and expenses. Not just the direct expenses, but small capital purchases such as a new computer! In addition you can register to be assessed on the fixed rate scheme. Please refer our blog on the Flat Rate Scheme. Although an umbrella company can register for VAT, it can not operate under the Flat Rate Scheme, as its registration would be for all its clients and its own costs.
If most of your direct expenses are reimbursed by your client then you are unlikely to have a high level of recoverable VAT. The flat rate scheme provides a simple calculation for VAT payable, but this also allows for a standard amount of recovery based upon your trade. In simple terms, if you invoice your client 20% VAT, you may only pay over to HMRC 14%, depending on the rate set by HMRC for your trade. The remaining 6% would stay in your business. You also have the cash flow benefit of the VAT received, as there is a delay in paying the VAT to HMRC. As the VAT period is normally 3 months, plus a further 5 weeks for payment, the average cash flow benefit is 2 months.
I will leave the technical details for now, but The Helpful Bean Counter will provide a full VAT service for your personal services company as part of our monthly charge.
Another benefit of the personal service company is that you can treat your spouse as a shareholding Director and therefore take a Dividend or even a Salary if they are contributing to the activities of the Company. You may also incur more general costs, such as running a small office from home, or travel and expenses not directly involved in a specific contract assignment. For example going to networking and other events to promote your services. A good Accountant can advise on this.
The umbrella company is definitely an efficient way to maximise your earnings. But it is very process driven and the writer believes that the longer-term holistic approach of the personal services company is more efficient and flexible. The umbrella company process is really just a payroll service that pays a regular dividend. Whereas once the personal service company has been set-up it can be used to develop other business activities. For example, my company Wordsfinance Limited was used as my own personal service company and this is now used for our accountancy practice, The Helpful Bean Counter. In fact, the wider the business activities are, is a good defence against IR35. New focus on IR35
The Government and HMRC are closely monitoring the use of both umbrella companies and personal services companies. Again please read my comments in New focus on IR35
I have only briefly tackled many of the issues in this short blog, but there are still significant benefits in running a personal service company. Changes in the structure of employment over the next decade will result in more workers becoming freelancers, contractor or whatever word the sector uses to describe this form of flexible working. The avoidance of taxation is not illegal, but it is increasingly becoming less morally tolerated. The objective in the writer’s view is to keep within the boundaries of what is morally right and I believe that a well-run personal services company is better in the long term than an umbrella company arrangement.
The main disadvantage of a personal service company is that it requires good administration and accounting. Busy freelancers do not have the time or probably the inclination to do this. But this is the reason why our proposition at the Helpful Bean Counter is appropriate for you. If you want more information, please contact Martin Samuel at firstname.lastname@example.org or 07989 011240 / 02393110395