A Guide to Managed Service Companies

 

Since the beginning of contracting for employment there have been various methods of keeping in line with HMRC including through the use of an Employee Benefit Trust, an Offshore Intermediary or other tax vehicles. Some have promised to create high income retention levels above what is reasonable of common in the circumstance – these tax vehicles turned out to be quite temporary in nature. When HMRC realized the implications relating to contractors evading taxes they were swift to reconcile their accounts.

 

The Managed Service Company was the most popular of these schemes – also known as a Composite Company, a managed service company as a form of company structure which grouped contractors under a corporation that was managed by a service provider. The MSC would go on to provide the same benefits to contractors as they would receive in a limited company in terms of tax advantages while taking the related responsibilities. This meant that the contractor was providing the same services as before only under an MSC in which they had a share hold but did not have any control of. HMRC determined that this was not acceptable and IR35 was seen by many contractors involved in an MSC.

 

HMRC Legislation on Managed Service Companies

 

New legislation was passed that prohibited companies from working in this manner. The ‘Tackling Managed Service Companies’ legislation was proposed to target these companies and composite structures which determined that any person working in that manner would be deemed an employee and their tax status would reflect this. 2006 saw any tax advantage of being involved in such a composite structure rescinded and including wide power including recovering back PAYE and NIC from third parties. The income that was received by workers from thereon would be subject to regular Class 1 employment level PAYE and NIC contributions and was enacted into law in 2007. From 2007 on a contractor would have to show they operated their own business on their own behalf or be obliged to pay Class 1 contributions.

 

Necessary Legislation

 

With the high level of IR35 circumvention underway HMRC determined that the only way to bring all contractors in line was through the addition of clarifying legislation. Under the IR35 legislation however the only way that contractors could be paid via dividends was if they fell outside of IR35 and it was the opinion of HMRC that this was not the case with Managed Service Company contractors. HMRC saw a massive growth in the number of such composite structures in the years up to 2007 and this was leading to losses both losses for the Treasury and difficulties in trying to collect outstanding liabilities. The major difficulty from HMRC’s perspective was that MSC’s held no tangible assets, and therefore was difficult to collect outstanding debts from – and they were also able to cease trading and be wound up very easily, often with their contractors simply moving to a new service company.

 

How the Legislation Works In Practice

 

The new definition of a managed service company as given by HMRC is a company that provides services of individual contractors to third party clients which are also involved in the service provision. Involved is defined as sharing in the service provision and the way the provision is paid.

 

The legislation states: “An accountancy/tax adviser, whether or not professionally qualified, who provides advice to clients who are service companies is not an MSC Provider merely by virtue of their client base. The test is whether a person is carrying on a business (or a discernible part of their business) of promoting or facilitating the use of companies to provide the services of individuals.”

 

The overall effect of the legislation was that HMRC had wider powers to collect outstanding PAYE and NIC contributions from contractors as well as third parties. It also made it impossible to eliminate the tax avoidance in the first instance by bringing in stringent policies which all contractors and composite tax structures had to adhere to. This created many IR35 investigations into managed service companies who mainly responded by dissolving their businesses. The legislation clarified that it applied to any MSC dealing with UK contractors regardless of whether it was located abroad or not.

 

Did the Legislation Affect Umbrella Companies?

 

HMRC clarified that the legislation did not apply to umbrella companies since it stipulated that the contractor had to be a shareholder of the company and receiving their income in dividends. A PAYE umbrella company is secure because by its very nature it is paying all the PAYE and NIC’s that HMRC expect. The legislation stated: “Individuals working through Personal Service Companies (PSC) that are not within the new definition of a MSC and individuals working through Umbrella Companies.” They further qualify this by noting that: “In umbrella companies workers are treated as employees of the umbrella company and all payments to workers as employment income… Consequently the third condition is not met and the umbrella company does not meet the definition of a Managed Service Company.” With the combination of IR35 and Onshore or Offshore Intermediaries Legislation as well as the MSC legislation was that most loopholes and tax vehicles facilitating them were closed again.