Managed Service Companies
Alongside being in business on your own account - either as a sole trader or using a limited company, (or using an umbrella company) there were, until 2007, popular alternative schemes for IT contractors in the form of Managed Service Companies or Composite Companies. This form of company structure placed contractors into groups of shareholders in a corporation owned and run by the service provider, providing contractors with the tax benefits of working through a limited company without the overall responsibility.
HMRC announced legislation to remove the tax advantage offered by using such "MSC" schemes in December 2006. Proposals, including measures to enable HMRC to recover PAYE and NICs debts from third parties, were announced on the 6th December 2006. In the Treasury's document Tackling Managed Service Companies, the following excerpt lays down the intentions of the legislation:
"The Government is taking action to tackle Managed Service Company (MSC) schemes which are used to avoid paying employed levels of tax and NICs. Income received by workers in MSCs in relation to services provided through the MSC will be subject to employed levels of tax and NICs, with the MSC obliged to operate Pay As You Earn (PAYE) and deduct tax and Class 1 NICs on that income - and the rules for tax relief for travel expenses will be the same as for other employed workers. The Government will also address the problem of MSCs escaping payment of tax and NICs due by allowing the recovery of these debts from appropriate third parties.
"This will protect the Exchequer and ensure a level playing field for compliant businesses and workers. The Intermediaries legislation will remain in place for Personal Service Companies."
After a period of consultation, managed service company legislation became law in April 2007 with some additional aspects (including debt transfer, see below) coming into force in August 07 and in January 2008.
Managed Service Companies are defined by the HMRC as those that provide the services of individuals to third party clients and are "involved" such as, benefiting financially from the provision of those services to clients, influencing or controlling the provision of services or the way in which the payment for services is made. (Thereby demonstrating the contractor is not in business on their own account and with full responsibility and control over their business.)
An MSC is defined by HMRC as "a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals". Furthermore, for the MSC legislation to apply the service provider must both fulfil the definition of an MSC Provider and be involved with their client companies.
HMRC guidance further states "An accountancy/tax adviser, whether or not professionally qualified, who provides advice to clients who are service companies is not an MSC Provider merely by virtue of their client base. The test is whether a person is carrying on a business (or a discernable part of their business) of promoting or facilitating the use of companies to provide the services of individuals."
On the question of umbrella companies being within the scope of the legislation, HMRC guidance also states "In umbrella companies workers are treated as employees of the umbrella company and all payments to workers as employment income... Consequently the third condition is not met and the umbrella company does not meet the definition of a Managed Service Company."
According to HMRC, MSC schemes were "growing rapidly" in the years leading up to 2007 and HMRC's guidance on MSCs and Transfer of PAYE and NICs debt outlined the "difficulties" faced by the government in collecting liabilities since "debt often cannot be collected from an MSC because MSCs generally have no tangible assets making it easy for them to be wound up or simply to cease trading and for workers to move to a new MSC."
HMRC therefore sets out other parties, relevant to the 'contractual chain', who are within the scope for debt recovery.
Appropriate third parties are deemed to be those which have "encouraged, facilitated or otherwise actively been involved in the provision by the MSC of the worker". MSC scheme providers, and directors, office holders or associates of the MSC, will therefore be pursued by the taxman for the recovery of employment taxes. Workers in the MSC remain within the scope of the debt transfer provisions, and are liable for debts when they can be shown to have known that they were operating for a MSC.
Third parties, who could reasonably be expected to know they were dealing with an MSC, will only have the debt transferred to them if the debt cannot be collected from the scheme provider or the director, office holder or associate of the MSC.
Key facts below:
- From 6 April 2007 all payments received by individuals providing their services through Managed Service Companies (MSCs) will be subject to PAYE;
- From the same date the cost of travel from the individual's home to the individual's place of work is not an allowable tax-free expense for workers within MSCs;
- From 6 August 2007 National Insurance Contributions are also due on all payments received by individuals working through MSCs;
- Also from August 2007, where the PAYE and NICs debts of an MSC cannot be recovered from the company, HMRC may transfer the debt personally to:
- The company's director; or
- The MSC Provider
- Debts may be transferred to other third parties from 6 January 2008.