A long-awaited test case concerning the Managed Service Company rules has been won by HMRC. This result will allow HMRC to collect an estimated £6m in back taxes.
In May 2016 Rebecca Cave reported on the very first judgment of the tax tribunal relating to the Managed Service Companies (MSC) legislation. That first MSC case has now found its way into the upper tier tax tribunal (UTT) on appeal, and the UTT has now issued a judgment dismissing the appeal.
The MSC legislation was introduced in April 2007, as a reaction to the perceived mass marketing of personal service companies (in particular, so-called composite companies).
The MSC rules work by asking whether there is an ‘MSC provider’ – a business promoting or facilitating the use of companies – and then asking whether that MSC provider is ‘involved’ with a given service company.
If there is ‘involvement’ then the MSC rules bite and the service company is an MSC, resulting in PAYE becoming due on all payments to the worker (including dividend payments). A discussion of the facts to the original case can be found in the Chartergates newsletter of 29 April 2016.
First tier judgment
That first MSC case involved five service companies who HMRC had alleged were MSCs, due to the fact that an MSC provider, Costelloe Business Services Ltd (CBS), was ‘involved’ with them. A standout feature of the original hearing was that the appellant companies all accepted that CBS was an MSC provider, so the case purely concerned whether or not CBS was ‘involved’ with the service companies. The original tribunal held that CBS was involved with the service companies and their appeals all failed.
To provide a context, CBS advised around 1000 clients and based on extrapolation of the tax due from the five cases heard. We estimate the overall liability in the CBS cases to amount to around £6m.
Unqualified accountant trap
The MSC legislation includes an exception which states that those who are merely providing legal and accounting services in a professional capacity cannot be MSC providers. HMRC claim that this exemption is only available to those who are professionally qualified and registered with a regulatory body (I wonder why the legislation does not simply say this).
On the face of it at least, every accountant providing accountancy services to service companies is ‘facilitating’ the use of those companies, and a large proportion of these accountants are either not professionally qualified, unregulated, or both, which – according to HMRC’s interpretation – would make them MSC providers as defined.
As there are five possible ways in which an MSC provider can be ‘involved’ with a service company, and they are defined very widely to encompass even exerting influence over the way in which payments are made to the individual (which surely any decent accountant providing sound tax advice should be doing) then the ramifications of this expansive interpretation are extremely worrying.
Debt transfer rules
The MSC legislation also includes corporate and personal debt transfer provisions which are wider than any other piece of tax legislation. These impose potential tax liabilities on the MSC itself, its directors, the MSC provider and its directors, or on any other person who has even indirectly encouraged the use of the MSC. There is a recipe for a catastrophic and unexpected tax liability to hit the accountancy profession and those working within it.
Was CBS a MSC provider?
The UTT allowed the appellants to resurrect the argument that CBS was not in fact an MSC provider after all – the opposite of the position it conceded in the FTT case.
At the UTT the appellants argued that an MSC provider must be promoting or facilitating the services provided by the service companies rather than just promoting the use of companies generally. This argument was roundly rejected by the UTT. Perhaps surprisingly (and unhelpful from a wider perspective) no argument was put forward that the ‘legal and accountancy’ exemption might apply, despite the fact that CBS had employed a qualified accountant.
Unfortunately, this UTT judgment leaves us none the wiser in terms of the judicial interpretation of the extent of the MSC rules. There is some commentary in the judgment regarding the potential for all sorts of ‘facilitators’ of service companies to be inadvertently swept up by the onerous MSC rules, such as payroll providers, but no conclusion on exactly which service providers would be caught.
Given the potentially enormous tax liabilities resulting from the MSC rules, and the fact that there is personal liability under the debt transfer legislation, this is a highly unsatisfactory position of uncertainty.
Appeals against factual findings such as this one are difficult to sustain. The service companies were always facing an uphill struggle. However, we cannot help but feel that an opportunity for some much needed clarification has again slipped through the judicial grasp.
*This article was edited 31 Jan to correct the date of the MSC legislation an edited on 1 Feb to correct the HMRC arguement at UTT*