The Managed Service Company (MSC) legislation has made the headlines once again – in 2022 – as several contractor accountancy firms – and their clients – are being investigated by HMRC.
What is the Managed Service Company Legislation?
The MSC rules were introduced to tackle tax avoidance via composite arrangements, whereby a service provider would provide a wide range of services for its limited company clients – who were also shareholders.
The arrangement would provide these workers (shareholders) with all of the tax benefits associated with working via an intermediary, but without having to take on any of the responsibilities associated with running a company.
According to HMRC, the definition is as follows:
In essence, a scheme provider promotes the use of these companies and provides the structure to workers. The worker, despite being a shareholder (or partner), does not exercise control over the company.
The Government introduced the infamous IR35 rules in 2000 to clampdown on perceived ‘disguised employment’, whereby if the intermediary were not in place, a worker would be an ’employee’, and taxed as such.
However, the tax authorities believed that many workers were simply ignoring the IR35 rules, and many who would be deemed to be ‘outside’ IR35 were using composite companies.
As a result, the MSC Legislation was introduced via Chapter 9 of the Income Tax (Earnings and Pensions Act) 2003.
From 6th April 2007, all income received by companies deemed to be a Managed Service Company would be subject to PAYE income tax and National Insurance.
Crucially, transfer of debt arrangements were also put in place to ensure that any liabilities would transfer up the chain – from the MSC itself to its directors, the MSC provider itself, and other third parties.
Clearly, the MSC legislation was very effective, as composite companies were rendered unviable overnight.
Although IR35 and the MSC rules are separate pieces of legislation, the effect – if caught – is the same, from a tax point of view. All of your income will be subject to PAYE and NICs.
You can access the full list of HMRC’s MSC-related documents in ESM3500.
A handy 5 minute video guide to the MSC rules
How do you recognise a Managed Service Company?
To meet the definition of an MSC, a company must fulfil 4 conditions:
- The company mainly or wholly provides ‘services of an individual to end clients’.
- The individual (shareholder) receives money for work done that is either the total payment received by the company, or almost equal to the full payment.
- Payments made to the individual are higher than they would be if they had been subject to standard taxation on employment.
- An ‘MSC Provider’ must be involved with the MSC.
What is an MSC Provider?
An MSC Provider is a person or business who facilitates the use of limited companies to provide the services of individuals.
Here are the main signs that a business is operating as an MSCP:
- It benefits financially from providing services to individual clients, via a limited company. Typically, it would take a percentage of the client’s income, rather than a fixed monthly fee, for example.
- It has an influence over how its clients’ services are provided – indicating that the individual worker is not truly in business on their own account.
- It influences how payments are made to the individual clients, e.g. tells clients how much to pay themselves. A company’s directors should decide how to distribute profits, not the MSCP.
- It controls the finances of the MSC, and shouldn’t be involved in things like choosing a business bank account to use.
- It promotes tax investigation insurance products to its clients, which (prior to 2007) would often ‘guarantee’ to cover any tax losses suffered by clients in the event of being caught by the MSC, IR35, or other tax rules.
Due to the transfer of debt arrangements included within the MSC legislation, an MSCP could potentially be liable for any taxes owed by the MSCs it has provided services for in the past.
The 2019 Costelloe Business Services Ltd case
In 2019, HMRC won an MSC case at the Court of Appeal – Christianuyi & Others v. HMRC – which raised the profile of the MSC legislation once again.
In the case, Costelloe Business Services (CBS) was found to be an MSCP due to the significant level of influence it had over its contractor clients’ affairs. CBS was very involved in processing payments, and even controlled its clients’ bank accounts.
It was unsurprising that HMRC won the appeal.
Following the appeal, we reported that some contractors had received letters from HMRC’s Counter Avoidance department asking for information relating to contracts and bank account transactions. However, since then, things seemed to have quiet on the MSC investigation front. Until now.
MSC developments in 2022
We are aware that HMRC is currently investigating the activities of several accountancy firms who provide services to limited company contractors.
Thousands of clients have received ‘determination’ letters, as clearly, HMRC believes that these accountancy firms are, in fact, MSC Providers.
These letters are clearly worrying to receive, and the demand for payments (typically for a single tax year – 2018/19, for example) appear to be completely unrelated to the actual difference between the money earned by a contractor during the tax year in question, and the total tax owed under PAYE rules – if the contractor was a traditional employee.
It seems hard to understand how a typical contractor accountancy firm could possibly be an MSC Provider, given the attributes required to meet the legal definition we described earlier in this article.
However, the burden of proof, as ever, remains on the shoulders of the accountancy firms, and their clients.
So, what should you do if you have received a letter from HMRC?
- If you have received a determination letter, you have 30 days to appeal to HMRC. So, don’t delay.
- Don’t bury your head in the sand and hope the problem will go away, or that your accountant will deal with it.
- If you have tax investigation insurance cover, you should check with your provider to make sure it covers the cost of professional representation, should it be needed.
We are talking with the accountancy firms involved, as well as other colleagues within the industry, and will add further information as soon as we can.
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