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  • Gary Smith
  • April 28, 2020
  • 5 min read

Contractors & Accountants Beware: Don’t Overlook the Managed Service Company Legislation

If two or more contractors were to offer their services to clients under a limited company structure, could this be an effective way of responding to the upcoming changes to the IR35 off-payroll rules?

In our recent article on post-IR35 solutions for contract workers, we flagged up this multi-contractor consultancy model as a possible way forward. That said, wherever you have a pooling of resources under a single structure, contractors, employers and contractor accountants need to tread carefully.

It’s one thing for contractors to go down the route of company formation in order to establish a bona fide consultancy business. But let’s say that the company you’re operating under (or thinking of becoming part of) is less of a corporate partnership and more of a business services package: one that’s administered by a service provider, and one that perhaps promotes itself as a way of minimising your tax liability?

HMRC takes a dim view of such schemes; especially where their primary purpose is to reduce participants’ tax liability. Under the Managed Service Company (MSC) legislation, contractors found to be using an MSC will be liable for tax and NI as if they were employees.

What’s more, with all the commentary surrounding the off-payroll rules changes arriving in April, not much attention was paid to the taxman’s Court of Appeal win in a case concerning the business service provider, Costelloe Business Services Ltd. This case serves to highlight the fact that in determining whether the MSC legislation applies, the amount of control and influence the service provider has over contractors’ affairs is a crucial determining factor.

Here’s a closer look at the MSC rules, when they apply, and at what you need to do to avoid falling foul of them.

What is the Managed Service Company Legislation?

The MSC rules were introduced in 2007 in response to a growing number of composite companies that were emerging. Under these schemes, multiple contractor shareholders would typically operate through a single company, operated and controlled by a service provider. This provider would usually take care of invoicing, accounting and Companies House reporting, and sometimes would control users’ business bank accounts.

Scheme customers tended to benefit from favourable tax treatment: not least, the practice of being paid a very low basic salary, topped up by high dividend payments.

The legislation had the effect of amending the existing Income Tax (Earnings & Pensions) Act 2003. It means that if such a company meets the definition of a Managed Service Company, the contractors using it will be required to pay tax & NI as if they were employees.

Definition of a Managed Service Company

To be classified as an MSC under the rules, all four of the following must apply to your company:

  • The company must provide the services of an individual worker (i.e. you) to third party clients.
  • You must receive the majority of the payment made to your company for the services you have provided.
  • The payment you receive for your services must be greater than if this payment was treated as employment income. (In other words, you are benefiting from not having been taxed as if you were a direct employee of your end client).
  • A person who “carries on a business of promoting or facilitating the use of companies to provide the services of individuals” (in other words an ‘MSC Provider’) must be “involved” with the company (see below).

What is an MSC Provider?

This is defined in the rules as “a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals”. So for example, a firm that provides normal small business accountancy services or a recruitment agent that merely places contractors into positions with clients would not normally fall within the definition.

Furthermore, the MSC Provider must be ‘involved’ with your company. This essentially means pulling the strings in one of the following ways:

  • The MSC Provider benefits financially on an ongoing basis from the services you provide (this could be in the form of a pro-rata commission payment based on your income).
  • The MSC Provider influences or controls the manner in which you provide your services (n.b. There’s a difference between influence/control as opposed to merely providing you with advice).
  • The MSC Provider influences or controls the manner in which you receive payment.
  • The MSC Provider influences or controls your company’s finances or any of its activities.
  • The MSC Provider offers or promotes a product or service that makes good a tax loss.

Recovering unpaid tax: the debt transfer rule

If an arrangement is found to be caught within the MSC legislation, it can affect end clients and agencies as well as contractors themselves. Under the debt transfer rules, if the agency or client was found to be actively involved in using contracts operating through MSCs (e.g. promoting or recommending scheme usage), those parties can be held liable for unpaid debts arising through MSC usage.

What has the Court of Appeal decided recently concerning the MSC rules?

In May last year, the Court of Appeal decided on a case involving personal service companies set up and administered by Costelloe Business Services Ltd (Costelloe).

An earlier Tribunal hearing had found that Costelloe was indeed “involved with” the companies it set up and administered. This was because Costelloe promoted what was essentially a ‘business services package’ whereby it would handle much of the admin burden for those companies. It benefited financially from the arrangement via a fee structure, as well as controlling contractors’ payroll and operating each company’s bank account.

The question for the Court of Appeal to decide was whether or not Costelloe was actually a Managed Service Company provider. This depended on whether or not it was deemed to have carried on a business “promoting or facilitating the use of companies to provide the services of individuals”.

The contractors tried to argue that in order for this description to apply, Costelloe would have had to promote the contractor’s services to end-user hirers. The Court of Appeal rejected this interpretation. Rather, to be a Managed Service Company Provider, that provider need only promote the use of a managed service company structure: whether or not it promotes contractors’ services to would-be clients is irrelevant.

Where does this leave contractors?

  • First off, contractors should not lose sight of the potential benefits of company formation as a way of structuring their business. The MSC rules are NOT designed to catch out contractors who incorporate for what are invariably sound business reasons.
  • Neither does the MSC legislation affect company formation agents or small business accountants providing a normal range of services (although providers of such services need to be careful in how these services are packaged and presented).
  • Be extremely wary of “tax efficient” packaged service deals involving payment of commission dressed up as ‘accountancy services’ – even if that provider markets solely to contractors as opposed to both contractors and end-clients. These are exactly the types of arrangement HMRC is likely to be honing in on with growing enthusiasm.

And finally, as a rule, professionals should be advising and assisting you: not controlling how your business is run! For professional advice in optimising the structure of your business without inadvertently falling foul of either the MSC rules or IR35, speak to MJH Accountancy today.

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