One new global development is the fact that in many cases both companies buying the services and the professionals delivering these services prefer to enter into a free-lance commercial agreement instead of working under an employment agreement. Important logical questions to be asked are, “What would be the best legal structure for the professional involved to deliver the service?” and “Should the services be delivered as a company or as an individual?” The answer to these questions has important implications for the tax, legal, and financial responsibilities of the service provider.
The most appropriate structure will depend on the sort of work and type of clients. Typically, we see that most free-lance professionals tend to create a professional service company and operate as a corporation. This is due to client preference, as certain potential clients and agencies will only do business with those who operate as a corporation.
What are the benefits and pitfalls, if any, when working as a corporation?
There are many benefits when working as a corporation. As mentioned above, one of the advantages of working as a corporation is that it gives the professional access to a larger client pool,
which includes the typical client and those who have a preference for only working with corporate professional service companies.
Another important benefit of working as a corporation is the protection it provides to the individual against legal liability, which the “corporate veil” grants. However, it is important to note here that the corporate veil will not grant protection to the individual in cases of gross negligence or willful misconduct by the professional service provider.
In addition, the use of a professional service company creates the opportunity for the professional to structure his or her affairs in such a way as to lower the overall taxes that need to be paid on the income generated on the job. One of the main taxes that a professional service company lowers is the withholding tax, A withholding tax, also called a retention tax, is a government requirement for the payer for the service (the client) to withhold or deduct tax from the payment to the individual service provider, and pay that tax to the government. In most countries, withholding tax applies to employment income and in all jurisdictions the professional service provider’s payment for services rendered would be considered income. The amount of withholding tax on income payments other than employment income is usually a fixed percentage. But not always, as some governments have reacted to some countries that have tried to “work the system.”
In our daily practice here at Sadekya, frequently we see that professionals delivering services to clients internationally choose to use popular jurisdictions, such as the British Virgin Islands (BVI), to establish their professional service company. However, many countries apply a higher withholding tax percentage when payments are made to countries that are known to offer zero-tax protection to companies, such as the BVI.
By carefully selecting in which country to establish the professional service company, one can take advantage of tax treaties, lower the withholding tax, and make use of other corporate legal provisions to also lower or even eliminate the corporate income tax to be paid by the company.
The downside of using a professional service company are the costs involved to keep the company in legal good standing. In addition, the professional service provider cannot treat the corporation as his or her personal domain. For example, the professional cannot take money from the company without formally recording it as salary, a dividend, or a loan.
Despite the downside, it is clearly an advantage to any professional service provider to seek professional help in setting up the best legal structure in the right jurisdiction for his or her professional service to minimize the taxes paid, enhance legal protection, reduce administrative headaches, and maximize profits.
