Tax Legislation - MSCs (Managed Service Companies)
Managed Service Company Legislation
In the 2007 budget, the Government introduced new legislation relating to Managed Service Companies (MSC's) - found within Chapter 9, Part 2 Income Tax (Earnings and Pensions) Act 2003 (ITEPA). This legislation looks to re-classify the employment status of those contractors and the self-employed who provide their services through an intermediate provider. The income of the individual will be subject to National Insurance and income tax deductions on their gross earnings - in effect treating them as employees for tax purposes.
What is a Managed Service Company?
To determine whether an individual’s company falls under the scope of the legislation, it is vital to establish what an MSC is. For a company to be classified as a Managed Service Company the following four conditions must be met (Section 61B (1), Chapter 9, Part 2 ITEPA):-
- The company’s business consists wholly or mainly of providing (directly or indirectly) the services of an individual to other persons.
- Payments are made (directly or indirectly) to the individual (or associates of the individual) of an amount equal to the greater part or all of the consideration for the provision of the services.
- The way in which those payments are made would result in the individual (or associates) receiving payments of an amount (net of tax and National Insurance Contributions) if every payment in respect of the services were employment income of the individual.
- A person who carries on a business of promoting or facilitating the use of companies to provide the services of the individuals (“an MSC provider”) is involved with the company.
What is a Managed Service Company provider?
The Government does not look favourably on arrangements whereby scheme providers have control over the individual’s trade and company. The legislation therefore also refers to the existence of an MSC provider i.e. typically service providers who offer standard packages which specialise in ‘managing’ individuals who provide ser vices through a limited company. It is important to note that the new tax rules are not intended to catch those genuinely self-employed who are in business on their own account. HMRC state that many individuals are being herded into arrangements without fully understanding the consequences of such arrangements e.g. the associated director’s liabilities and loss of employment rights. HMRC state that these individuals would never knowingly enter into such arrangements and that, as such, one of the main aims of the legislation is to protect individuals.
An MSC provider is defined in the legislation as being ‘a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals.’ It is important, however, to note that being an MSC provider does not in itself mean that all the service companies which it services are MSC’s - the MSC provider must also be involved with the service company for which it acts.
An MSC provider is involved with the company if the MSC provider or an associate of the MSC provider:-
- Benefits financially on an ongoing basis from the provision of the services of the individual.
- Influences or controls the provision of those services.
- Influences or controls the way in which payments to the individual (or associates of the individual) are made.
- Influences or controls the company’s finances or any of its activities.
- Gives or promotes an undertaking to make good any tax loss.
Industry Models
Within the contracting industry there have been many companies offering different models under which individuals could operate. The new legislation will effectively change, and indeed remove, some of these structures and therefore we have detailed the most common types below.
- Composite structures, whereby many individuals are paid their income as dividends as a shareholder of a company (owned by the MSC provider), will fall under the new rules and as such PAYE and NIC will have to be deducted from earned income, effectively treating the individual as an employee for tax purposes but without the individual obtaining any employee rights. This is because HMRC do not class these individuals as genuinely being in business on their own account as they have no ownership of the company and do not demonstrate any control or management of the company.
- Personal Service Companies (PSC)/Single Member Companies, whereby the company is owned, controlled and managed independently of a service provider and the individual within the company is genuinely self-employed, do not fall within the scope of the legislation. HMRC have advised, however, that the current IR35 rules will continue to apply for such companies.
- A genuine Umbrella set up will be allowable under the new rules. This is where the individual fails the IR35 tests and is therefore classed as an employee of the umbrella company and both PAYE and NIC are operated on the total income less allowable expenses. Umbrella schemes are currently seen as useful for low paid or short term contractors as it reduces the administrative burdens for both the contractor and the end client.
- Accountancy firms in the traditional sense, which offer bookkeeping and accountancy services, are specifically excluded from the legislation provided they are merely providing legal or accountancy services in a professional capacity. (s61B, 3 ITEPA) Please note that the exemption does not stand just because you are an accountant i.e. an accountant acting as an MSC provider (by satisfying the conditions in s61B, 2 ITEPA) will still be caught by the legislation. It is likely that this area will be defined as further guidance and new case law emerges in this area.
- An alternative option for an individual may be to operate as PAYE through an agency, Sole Trader or Partnership etc but the appropriateness of such arrangements will always be dependant on an individual’s personal circumstances.
Transfer of Debt
The legislation also contains Transfer of Debt provisions (Section 688A, Part 11 ITEPA), which allows for the transfer of PAYE and NIC debts of an MSC to be transferred to third parties if HMRC cannot recover the debt directly from the MSC itself.
Debts may be transferred to an MSC’s director, the MSC provider, or any other third party that has directly or indirectly encouraged, facilitated or otherwise been actively involved in the provision of the services of the individual through the MSC.
Thus, a recruitment agency which dictates that any individual operating a PSC must operate through a preferred MSC provider may become liable for unpaid PAYE and NIC debts due to the fact that they have ‘encouraged, facilitated or been actively involved in the provision of the services of the individual through an MSC'. It is important that employment businesses and recruitment agencies do not force or steer individuals down an MSC route.