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PBR: Managed service companies – first in the firing line! By Rebecca Benneyworth

7th Dec 2006
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There was a clear indication in the Budget 2006 publications that tax motivated incorporation was still an issue for Government. The Red Book included an analysis of the issue at paragraph 5. 85 and indicated that steps would first be taken against managed service companies :

”5.85 Since the Pre-Budget Report, further evidence has emerged that employment income is being disguised as dividends in order to take advantage of the small companies’ tax rate, often encouraged by promoters of mass-marketed managed service company schemes. There is also evidence of some agencies, contractors and employers requiring workers to use corporate structures, thereby denying them employment rights as well as avoiding paying their fair share of tax and NICs.

5.86 The Government believes that all individuals and businesses must pay their fair share of NICs and tax, irrespective of legal form. It will continue to review the tax and NICs systems to ensure that this is the case and will bring forward proposals for discussion that are consistent with simplicity for compliant businesses, support for businesses in their aspirations to grow and maintaining the attractiveness of the UK as a business location. As the first stage of this review the Government will consult on action to tackle disguised employment through managed service company schemes.”

A very detailed study of the issues and suggested solution form part of the pre Budget pack, principally in a document entitled simply 'Tackling managed service companies'. This document examines the problem in some detail and suggests a radical solution.

Managed service companies, for these purposes include companies which are normally run by an outside provider (the “scheme provider”) who recruits workers to trade through the companies. The term encompasses both “Composite companies” in which a number of workers unknown to each other trade together, structured so as to maintain the profits at a level attracting the small companies rate of Corporation tax, and true “managed service companies” which are effectively “one man limited companies without the tears”. In both cases, the worker merely provides his services and notifies the scheme provider of his billing requirements. All of the administration is carried out by the scheme provider, and the worker is paid a weekly or monthly amount comprising three elements :

  • Small salary, at or near the personal allowance, thus incurring no PAYE and particularly no NIC liability (in some companies the effort is at least made to comply with National Minimum Wage legislation, producing a small NIC charge).
  • Reimbursed expenses.
  • Dividend.

These are the residual amounts from the billings, after retaining the scheme provider’s fees and an amount to cover corporation tax at 19%.

The worker does not participate in the management of the company, and is not viewed by the Government as “being in business on his own account” which of course is an element of the employment tests. It is Government’s view that the workers should be taxed as employees, as that is effectively what they are.

The mechanism of IR35 would in fact serve to ensure that at least some of these workers are taxed through PAYE and NIC, as MSC’s and composites are frequently marketed to those workers who may have a status issue as self employed individuals. They are offered the MSC as a way of eliminating the status issue for their clients. While this is perfectly true, those who have working patterns which would indicate employment merely move the PAYE and NIC liability from their client into the company through the mechanism of IR35. It is widely recognised, however, that the sector has made little or no effort to comply with IR35, and indeed rely on the fact that the MSC funds have all been distributed, and there are therefore no assets to meet an IR35 liability should HMRC successfully make a case.

The proposal now brought forward to deal with this issue might be seen as “son of IR35”. With a careful definition of those companies which are affected by the new legislation, those companies will now be excluded from IR35 completely, and all workers working within them will have deemed employment status vis-à-vis the MSC. This will make the company liable to operate PAYE NIC on all payments made to workers working through these structures.

The new legislation does not end here. There will also be changes to ensure that the normal rules about tax free expenses will apply to MSC’s as they apply to normal employees, but the final aspect of this new regime has yet to be fleshed out. It is this final aspect which will be crucial to the success of the new measure, and the draft rules are still being worked on.

In the same way as under present legislation, when the MSC just ignores IR35 leaving no assets from which to collect the tax properly due, it is always possible that MSC’s could fail to operate PAYE and NIC. In the event that companies were assessed to this tax and NIC, and there are inadequate funds to cover the liabilities, HMRC do have powers to collect the tax and NIC from the recipients of the pay. These existing powers in PAYE and NIC Regulations would therefore allow MSC’s to shirk their responsibilities, and for HMRC to be faced with complex individual recovery proceedings in every case.

Clearly, this is not the way to go forward, so additional legislation will allow recovery of such liabilities from specific third parties, such as the scheme provider and other related parties. An outline of suggested third parties who might be liable is included in the new document, but detailed definitions are not yet available. The intention is to catch anyone who might have materially benefited from the MSC business.

Draft legislation has now been issued for comment on this, and the new rules will commence in April 2007. The additional legislation concerning recovery provisions should be available for comment at the end of January 2007.

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Replies (6)

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By stephenusher
11th Dec 2006 17:30

would this legislation cover umberella companies

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By User deleted
11th Dec 2006 17:42

IR35 lives?
Rebecca -

Although IR35 is still with us, in recent months it has had the appearance of a toothless old moth-eaten lion (or should that be paper tiger?)

In view of Muscat v Cable & Wireless (and some IR35 cases that HMRC have lost), do you think they have now given up as a bad job their attack on individual one man band service companies to have a go instead at umbrella/composite companies?

Or is IR35 a snarling leopard prowling through the undergrowth just waiting for an opportunity to pounce again on unsuspecting contractors?

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By mikewhit
07th Dec 2006 12:20

Unforeseen consequences
An MSC can currently be used by someone who for regulatory reasons must trade through a Ltd Co, but:
a) wishes to outsource the admin and all payments & dealings with HMRC, Companies House
b) cannot legally do so (e.g. due to disqualification)

If MSCs are rendered obsolete by new legislation:
In case a), there will now be a class of people coerced into sorting out for themselves what was formerly done correctly and transparently by the MSCs, potentially giving rise to shortfalls or at least mistakes in tax payments and filings.

In case b), there does not seem to be a good alternative, unless a family member sets up as a mini-agency Ltd Co and employs the person.

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By NeilW
07th Dec 2006 15:56

Too complex
I notice that a note to the PBR explanation states that 'employment for tax purposes is not necessarily the same as for employment law purposes'.

The question has to be 'why'?

Surely the simplest solution here is to eliminate the agency legislation and intermediaries legislation and replace the lot with a simple rule that no amount of structure between a master and a servant will prevent a master servant relationship arising if the facts point to that, nor will it prevent the master from being ultimately responsible for the employment taxes and operation of the social security benefits for a servant. (ie a simple 'duck' test for employment - disregarding all other structures).

Add this to another simple rule that states that an indemnity for employment taxes and benefits on either a servant or any entity associated with a servant is unenforceable.

Contract law indemnities then take care of the rest of the chain if the client so insists.

Why wouldn't this work? Client either makes the relationship non-employment (avoiding the entire issue), or the contract chain is responsible from top to bottom for the employment taxes. HMRC goes after the biggest fish and leaves contract law to sort out the rest of the responsibilities.

Isn't it time to deal with the problem, rather than messing around patching up the symptoms?


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By mikewhit
07th Dec 2006 23:37

"Client either makes the relationship non-employment (avoiding the entire issue), "

But the point is that the proposals want to take out all MSCs regardless of whether there is 'disguised employment'.

The MSCs in my experience go to great lengths to undertake IR35 compliance reviews of the contracts and relationships, and hence should not be affected by legislation if it was looking for pseudo-employment.

But it appears that MSCs of any nature are now being targetted as a bad thing in their own right. This has all the indicators of another IR35 fiasco, but one which will grind on ultimately benefitting no-one.

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By mikewhit
15th Dec 2006 11:35

Non-"evading" users
"If the advantage of MSC is effectively nullified ..."

The advantage of an MSC is purely that of outsourcing administration, for pukka users.

The proposals will effectively place an extra tax on those wishing to do that, or drive them to self-incorporate with all the attendant scope for mistakes.

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