To understand the Managed Service Company (MSC) rules, given the limited case law on the subject, we must dive into the legislation (found at ss61A – J ITEPA (2003), and the corresponding Transfer of Debt legislation at s688A ITEPA (2003).
The legislation is lengthy and complex, but unlike other pieces of legislation that affect contractors, the language used in its drafting is clear.
David Harmer, Associate Director at Markel Tax.
When does the MSC legislation apply?
For the MSC legislation to apply, it requires three things:
- A (Personal Service) Company
- A Provider
- Involvement (by the Provider in the affairs of the Company)
All three of these key elements must be present for the legislation to apply. If the legislation does apply, the company must operate the , which means applying Tax and National Insurance Contributions (NICs) to all payments.
Clarification of the ‘The Company’
For the purposes of the legislation, ‘the company’ is one in which:
- Its business is that of wholly or mainly providing the services of an individual to clients.
- The individual receives all, or the greater part, of the payment made to the company for the services.
- The individual receives payments exceeding that which they would have received if all payments were subject to employment income.
This effectively defines any ordinary PSC i.e. the owner/shareholder (the contractor) who provides their services and receives the majority of the payment from those services via salary and dividend. If the company is operating inside IR35, then it would not fall into this definition as all monies received would be classed as employment income.
However, it is the next element which is fundamental for application of MSC legislation.
The Provider
It is the definition within the MSC legislation which is key to the application of it. The legislation provides that the company will be a managed service company if there is also:
a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals (“an MSC provider”) is involved with the company. (1)
Where a company and provider exist, the company will be an MSC.
The definition of an MSCP can simplified, and the MSCP must be:
- A person (entity) separate from the company
- Carrying on a “business” (i.e. trading) of promoting or facilitating the use of companies for the supply of services of individuals.
Importantly, it does not have to be the “whole” of the entity that does this. If only part of that entity is trading to promote or facilitate the use of companies for the supply of individuals, then that is sufficient.
This point would exclude commercial entities, such as commercial contractors using self-employed subcontractors and umbrella companies, as these are self-contained entities that provide commercial services to clients and are not carrying on the business of promoting or facilitating the use of companies. For example, a compliant umbrella company employs individuals, and will be operating employment income on all its employees.
The MSC legislation targets those entities which market themselves to individuals, promoting that the individuals should use a limited company to provide services. The provider offers to take care of all the administrative/legal/tax burdens of operating a company. For example, “We will set you up with a limited company and we will do everything for you, you simply provide your services as you always have done.”
Where a company and a provider exist, the company is an MSC and the provider is an MSCP (Managed Service Company Provider), therefore the MSC rules are in play.
However, the legislation only ‘bites’ if the MSCP is “involved” with the MSC.
Involvement: explained
The legislation itself provides definition of “being involved”, and additional clarification of the definition comes from the Christianuyi v HMRC (2019) Court of Appeal judgment (also known as the ‘Costello Business Services case’).
While that case did not deal with the definition of an MSCP (as it wasn’t argued), it did explore the ‘involved with’ provision. There are five statutory provisions to “being involved”:
- benefits financially on an ongoing basis from the provision of the services of the individual,
- influences or controls the provision of those services,
- influences or controls the way in which payments to the individual (or associates of the individual) are made,
- influences or controls the company’s finances or any of its activities, or
- gives or promotes an undertaking to make good any tax loss.
From the Christianuyi v HMRC (2019) Court of Appeal judgment, the court determined the following are examples that would bring an MSCP within “involved”.
- being paid only when the MSC is providing services to clients
- providing recommendation on how the MSC should take its money
- Influencing an MSC to use a preferred banking method
- automatic collection of monies to the MSCP
- having control of the MSC bank account
These are only some examples, and it is important to remember these points are only considered once it’s been established that an MSC exists.
The Debt
The result of applying the MSC legislation is that the company (you, the contractor) is liable for tax and NICs on all payments for services (in much the same way as an inside IR35 decision).
It is your responsibility to pay it, your responsibility to argue your case, and your responsibility to appeal a HMRC decision. You are liable, your provider is not!
The MSC legislation also introduced its own transfer of debt provisions.
If a debt under MSC falls due (meaning appeals are exhausted and the money must be paid), it can only be transferred to another party if HMRC considers the money is unlikely to be recovered from the MSC. For example, the MSC has already closed, or has no available funds.
The first option available to HMRC in transferring the debt is the MSCP and/or the director of the MSC (you, personally). However, it isn’t guaranteed that HMRC will transfer the debt to the MSCP if your company cannot pay what is owed.
How can contractors safeguard themselves from the MSC legislation?
As a contractor you are in the firing line for unpaid tax and NICs, so it’s important that you understand how the MSC legislation can apply to you.
The legislation is not designed to catch out contractors who use the services of an accountant or legal advice (the legislation clarifies that accountants and legal advisers don’t fall within the definition of an MSCP by providing professional services).
However, there is a fine line between engaging a provider for professional services and engaging a provider to effectively run your company for you.
It would be unfair to expect every contractor to have an in-depth understanding of all tax legislation, company laws, and accounting rules. However, it is important for every contractor to understand what trading through a limited company means, including what their responsibilities as a company director, and where the company’s money is being spent.
Judging by HMRC’s activity in 2022, they view that a service-offering targeted at individuals to supply their services through companies, coupled with the use of automated online portals, is sufficient to apply the MSC legislation, on the basis there is active promotion, active facilitation, and influence over the company.
A key part of the argument is the use of an online portal for more than the contractor simply providing information to its adviser and to manage its own affairs. The argument is that the portal is used by the provider to allocate monies as the provider sees fit (in a tax-efficient way), which means the contractor isn’t running their own business, instead they are passively accepting what is being done for them.
The use of an online portal should not cause issues, however, there is an issue if a provider automatically allocates salary and dividends without consulting the contractor and without their approval.
Questions you should ask yourself…
We would encourage all contractors to be certain they understand the services they are receiving from any accountancy service provider and look out for the HMRC flags.
For example, do you need to approve all payments made by your company?
And then also answer the following five questions:
- Do you authorise all returns made to HMRC?
- Do you have control of your company’s income?
- Are you forced to use a preferred bank?
- Do you only pay accountancy fees when your company is actively providing services?
- Do you fully understand all the services you are receiving?
Carrying out your due diligence now, can save a lot of headaches in the future and safeguard yourself against potential HMRC liability under the MSC legislation.
If you are unsure of your position and would like assistance, book a call with one of the experts at Markel Tax. Call 0345 351 2600 to book your appointment.
Original publication, Friday 2nd Dec 2022
Sources:
- ESM3515 – Managed Service Companies (MSC): MSC Providers – HMRC internal manual – GOV.UK (www.gov.uk)
https://www.contractoruk.com/managed_service_companies/managed_service_company_msc_legislation_experts_overview_contractors.html
https://www.gov.uk/guidance/how-to-calculate-the-deemed-employment-payment
https://www.gov.uk/tax-and-chancery-tribunal-decisions/christianuyi-ltd-and-others-v-the-commissioners-for-hm-revenue-and-customs-2018-ukut-0010-tcc
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