As a recruitment business, do you know if you have been unwittingly referring your contractors to an MSC provider?
In the aftermath of HMRC winning a key Managed Service Company (MSC) case at the Court of Appeal, the time is now for recruitment businesses to review internal processes to ensure they are not going to be left with a huge tax liability.
History and background of Managed Service Legislation:
MSC legislation was brought in as part of the Finance Act 2007 to combat tax avoidance schemes that successfully side-stepped IR35, called Composite Companies.
IR35 was introduced in 2000 to prevent perceived tax avoidance using one-man limited companies. Back then, dividend tax was effectively zero, below the higher-rate income tax threshold, so a contractor earning less than £28,000 could draw a minimum wage salary from their company, which would be subject to PAYE deductions, but draw the remainder of their contractual earnings as dividends, net of corporation tax, but free of income tax. Contractors on higher rates would only be subject to dividend tax above the higher-rate threshold.
Since IR35 targets the use of Limited Companies or Personal Service Companies (PSC) which provides the services of individuals, if the individual has a shareholding of less than 5%, IR35 ceases to apply.
Organisations took advantage of this fact by grouping 21 or more contractors into a Composite Company as shareholders. The company would be controlled by the main organisation which would control the bank accounts, handle contracts, business insurances, facilitate invoicing and payments and, therefore, ensure the other shareholders did not act inappropriately against each other.
Composite Companies thrived in the years after IR35 was introduced, massively reducing the effectiveness of the IR35 legislation. At the same time, organisations were offering a service which, effectively, was a Limited Company as a product to independent freelancers and contractors. The main organisation would effectively do everything; facilitate company formation, handle contractual documents, invoice agencies and clients, facilitate payments to contractors, make payments to HMRC and the filing of annual company accounts and returns – this service is what we now know and consider as a Managed Service Company.
Legislation was introduced at Finance Act 2007 to stop MSC’s in their tracks as HMRC knew these contrived structures were costing the Exchequer massively. The MSC legislation essentially regards any PSC that was using an MSC Provider i.e. an umbrella company or accountant offering a standardised company product, to be a Managed Service Company.
The MSC legislation was written in a way to provide for unpaid tax debts of MSCs to potentially be chargeable to various involved parties, including agencies or end-clients. This put the onus of due diligence onto agencies so that any umbrella company that tried to flout the legislation would find most recruitment businesses would not contract with them. As a result, the Composite Company structure almost disappeared from the marketplace overnight.
Details of this case:
The Court of Appeal has dismissed a key appeal which involved the supply of contractors via an MSC with a ruling in favour of HMRC.
The case, Christianuyi Ltd and others v HMRC, relates to five limited companies that all provided the services of individuals as contractors. The companies had been set up for the contractors by Costelloe Business Services Ltd, which was a company that was dissolved in 2016.
HMRC argued that the limited companies in question are, in fact, MSCs and wanted to collect the additional tax due to payments made to the contractors between 2007 and 2010. An amount of nearly £160,000 between the five companies.
The contractors appealed to the First-Tier Tribunal in 2016, who upheld HMRC's decision. The case was then escalated to the Upper Tribunal who ruled in favour of HMRC in 2018.
The contractors were allowed to appeal the Upper Tribunal ruling at the Court of Appeal, who dismissed the appeal and found that Costelloe Business Services Ltd was an MSC Provider which was involved with their clients’ companies.
The MSC Legislation:
The MSC rules are contained at Income Tax (Earnings and Pensions) Act 2003 Part 2, Chapter 9, which was inserted by Paragraph 4 of Schedule 3 to the Finance Act 2007. The rules took effect from 6th April 2007 for income tax and from 6th August 2007 for National Insurance.
An MSC Provider is any company who carries on a business of promoting or facilitating the use of companies to provide the services of individuals. In theory, this is easy to demonstrate but isn’t enough for MSC to apply.
The main part of the legislation is whether the MSC Provider is actually involved with the PSC. If this was the case, this would make the PSC an MSC, and all payments to the contractor must be treated as employed income.
For an MSC Provider to be involved with a PSC, one of the following criteria must apply:
- The MSC financially benefits on an ongoing basis from the provision of the services to the contractor i.e. fixed monthly fees
- The MSC manages the supply of services (invoices, accounts etc.)
- The MSC controls the way in which payments to the contractors are made
- The MSC controls the company's financial activities
As a recruitment business, if you have been or are referring contractors to a service provider that promotes the use of PSC’s then you need to consider the services which that company provides and whether they could be considered an MSC Provider.
From HMRC’s point of view, the MSC legislation is considered much easier to prove than the highly complicated employment status criteria used to determine an IR35 status. Therefore, HMRC is expected to focus more seriously on MSC cases moving forwards. The transfer of debt provisions allows HMRC to transfer MSC tax debts that are otherwise uncollectable to the MSC’s directors (the contractor), the MSC Provider, Recruitment Agencies and, finally, the end-clients. This means HMRC is almost certain to be able to collect the unpaid tax from one party or another and could be an extremely worrying prospect for those in the supply chain that haven’t previously considered the MSC legislation when formulating Preferred Supplier Lists (PSLs) of Limited Company or PSC service providers.
Contractors should expect to see HMRC targeting more and more MSC schemes in the near future, and recruiters need to make sure they are not referring their contractors to an MSC Provider and, ultimately, putting themselves at risk.
As a compliant umbrella company, iConsult is not an MSC provider so recruitment businesses are able to refer contractors to us without the unnecessary worry that the tax authorities may knock on their door to collect unpaid taxes.
As a recruitment business, if you are concerned you are inadvertently using an MSC provider and wish to discuss partnering with iConsult, please contact our dedicated customer service team who will be happy to help.
iConsult – 0117 434 0004
Managing Director at iConsult, Umbrella company for UK based Contractors, Freelancers & Self Employed.