If you work through a limited company and have a specialist company supporting your financial affairs then you might want to be aware of the government’s Managed Service Company (MSC) legislation.
But what is an MSC, and why should you be aware of it?
An MSC is basically when a contractor’s business is controlled too tightly by another business that undertakes a lot of the tasks that a company director is legally obliged to do.
It is designed to combat scenarios whereby a third party might contrive to have their workers as self-employed directors of their own businesses, and therefore be paid gross for their work undertaken for clients, whereas in reality these workers are not self-employed directors as they have minimal control over their company.
The company exerting the control over these “self-employed” businesses is known as a Managed Service Company Provider (MSCP). The “self employed” business that is being controlled is a Managed Service Company, or MSC.
Imagine, for instance, an MSCP made up of approximately 20 contractors who (apparently) run their own limited companies. However, rather than the contractor taking care of the decisions made by the limited company and its business, another company makes those decisions and runs the company with little or no input from the contractor. The company making all the decisions would likely be classed as an MSCP. The MSCP would take care of all invoices and accountancy administration, and may even control the bank accounts of the contractor’s company.
HMRC does not look favourably on this type of setup as participants could take advantage of the tax benefits open to them as a contractor, while essentially working in the same manner as an employee.
This is another reason that contractors need to be aware of the legal responsibilities associated with being a limited company, or personal service company (PSC) director, and the fact that these responsibilities cannot be delegated.
You can read more about the differences between a sole-trader and PSC director here
The problems that MSCPs provide
To get a bit more technical, if a contractor is self-employed and is providing their services through a limited company (the MSCP), but that limited company is effectively controlled by a third-party – then it could be classed as a tax avoidance scheme.
It could be that your contractor assignment income should be reclassified as standard employment income if you’re operating through an MSCP, which means that income should be subject to income tax and National Insurance Contributions like any other employees.
To tackle the problem, the government introduced Managed Service Company legislation, which came into force in 2007.
HMRC had become aware that MSC’s were in some cases paying workers national minimum wage which attracted minimal employer NIC contributions and then issuing dividends to provide further payments to the worker who was also a shareholder of the MSC. This resulted in lost revenue to HMRC.
The legislation was designed to remove an MSC’s tax advantages that arise from the contractor being paid a low salary and seeing their income boosted by dividends.
Those caught out by the legislation will be liable to pay full PAYE income tax and National Insurance Contributions on their income from the MSC.
HMRC will also look into all previous payments and reclassify them if an MSC falls under the legislation, meaning that back taxes may need to be paid.
The legislation provides that if a company is found to be a MSC, the payments made to a worker will be classed as “deemed employment income” and deductions for tax and other charges required to be made accordingly. The legislation also provides that HMRC can seek to enforce the liability to pay the deductions, against other parties in the supply chain or, in some cases, their associates, in the event that the MSC itself becomes subject to an insolvency event. This is known as the debt transfer rule.
The case of Costelloe Business Services (CBS)
Costelloe Business Services Limited (CBS) was one of the first companies to be investigated under MSC legislation at a Tax Tribunal in 2016, with HMRC classing CBS as an MSCP.
The case, Christianuyi & Others v. HMRC, centred around a number of Personal Service Companies (PSCs). Each of these PSCs were providing the services of an individual who was their company’s majority shareholder and sole director.
Each of these PSCs utilised the services of CBS to provide their support services to PSCs to be able to operate. The case had to clarify whether:
- CBS was an MSCP, and
- Whether CBS controlled or influenced the PSCs, referred to in the legislation as “being involved”.
If found to apply, then all parties would fall under MSC legislation. The First-tier Tribunal and Upper Tribunal found in favour of HMRC, meaning that the income received by the individuals had to be reclassified as employment income and taxed accordingly.
CBS went to the Court of Appeal and lost, with the Court of Appeal unanimously agreeing with HMRC that CBS was an MSCP, and that the companies involved were MSCs.
An MSCP is a company that is in the business of promoting or facilitating the use of companies to provide the services of individuals.
In this case, Costelloe provided a standardised product to clients, and did not have meaningful discussions with its clients about its services or the salary levels the individuals would be drawing. In most cases, it never met the clients, dealing only by letter, phone or electronically.
False minutes of meetings declaring dividends were produced, and genuine instructions from clients were rarely taken as to levels of dividend payments.
In addition, Costelloe was heavily involved in the banking arrangements of its clients, from which it earned and retained large sums of bank interest monies.
All of these factors pointed towards an undue level of involvement, meaning that the arrangements were contrived and not genuinely PSCs over which the directors had proper control.
Who is affected by Managed Service Company legislation?
As you’d expect, contractors who are suspected to be operating through MSCs and MSCPs will be affected by the legislation.
Whilst the MSC legislation is deliberately very broad it is worth noting that businesses which are merely providing legal or accounting services in a professional capacity are not MSC providers.
A standard relationship with an accountant where a PSC retains full control over the business finances is unlikely to be caught under MSC legislation.
MSC legislation, though, could also unwittingly affect agencies and clients. The legislation includes a ‘debt transfer rule’ which can make agencies, clients or the MSCP liable for the unpaid debts and taxes that have accrued from the MSC’s non-payment of income tax and NICs.
This can occur where the MSC cannot afford to pay the liabilities or becomes subject to an insolvency event, the debt can be passed to another party in the supply chain through the debt transfer rule to provide HMRC with increased chance of recovery.
For the debt transfer rule to apply, though, agencies and clients must actively be using the services of contractors working via an MSC or MSCP.
How can agencies and clients identify MSCs and so protect their position? One of the best ways they can do it is by constructing a Preferred Supplier List (PSL), doing their due diligence and adding only those contractors and companies that have passed their audit to it.
Find out more about how to create an effective PSL here.