Managed Service Company (MSC) legislation: an expert's overview for contractors
To thoroughly understand the Managed Service Company (MSC) rules, given the limited case law on the subject, there is little option but dive into the legislation (found at ss61A – J ITEPA (2003), with corresponding Transfer of Debt legislation at s688A ITEPA (2003).
The legislation itself is lengthy and complex. However, unlike some other pieces of legislation affecting contractors, the language used in its drafting is clear and exacting, writes David Harmer, associate director at Markel Tax.
When does the MSC legislation apply?
In order 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 effect is that the company must operate the ‘deemed payment’ calculation -- that is, applying Tax and NICs to all payments.
Close-up on 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 providing their services and receiving the majority of the monies from those services by way of dividend and salary; in other words, you, the contractor. If the company were operating within IR35, then it would not fall into this definition as all monies received would be subjected to employment income.
But this does not of itself ‘do’ anything. What is needed for application of MSC legislation, is the next element which is fundamental.
If I can go without quoting legislation, I often will.
However, the definition within the legislation 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.
Where a company and provider exist, the company will be an MSC.
The definition here of an MSCP can be broken down and exploring this definition, the MSCP must be:
1. A person (entity) separate from the company
2. 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 that entity that does this. When looking at the entity as a whole, 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.
Nevertheless, this would exclude commercial entities such as commercial contractors using self-employed subcontractors and umbrella companies. --because these are self-contained entities that are providing commercial services to clients, and not carrying on the business of promoting or facilitating the use of companies (and in any event, a compliant umbrella company employs individuals, and would therefore be operating employment income on all its employees).
What the MSC legislation targets is those entities which market themselves to individuals, promoting that the individuals should utilise 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’ll set you up with a limited company and we’ll do everything for you, you just keep providing your services as you always have done.”
Where a company and a provider exist, then the company is an MSC and the provider is an MSCP, and therefore the MSC rules are in play.
The legislation only ‘bites’ however if the MSCP is “involved” with the MSC.
The legislation itself provides definition of “being involved”, and we have additional clarification from the Courts 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 this was not argued), it did explore the ‘involved with’ provision. There are five statutory provisions:
(a) benefits financially on an ongoing basis from the provision of the services of the individual,
(b) influences or controls the provision of those services,
(c) influences or controls the way in which payments to the individual (or associates of the individual) are made,
(d) influences or controls the company’s finances or any of its activities, or
(e) gives or promotes an undertaking to make good any tax loss.
I will not explore each provision in detail. But from the Christianuyi 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 that these are ONLY considered once it has been established that an MSC exists.
The result of the MSC legislation applying it that the company (i.e., you, the contractor) is liable to tax and NICs on all payments for services (in practically the same way as an inside IR35 decision). It is your responsibility to pay it; your responsibility to argue your case, your responsibility to appeal an HMRC decision. You are liable, your provider is not!
As mentioned above, the MSC legislation itself also introduced its own, draconian, transfer of debt provisions.
I will not detail the mechanics of their operation; however, 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 it is unlikely to be recovered from the MSC. For example perhaps, the MSC has already closed, or has no funds. However, the first option open to HMRC in transferring the debt is the MSCP and/or the director of the MSC (you, personally). Note, it is not guaranteed that HMRC will transfer to the MSCP if your company cannot pay.
How can contractors safeguard themselves?
The cardinal rule is that knowledge is power. Contractors are the ones who are in the firing line for unpaid tax and NICs, so it is paramount you understand how the legislation can apply.
The legislation is not designed to catch out contractors who utilise the services of an accountant or legal advice (indeed the legislation, while not providing an outright exemption, does clarify that accountants and legal adviser do not fall within the definition of an MSCP simply by providing professional services). In fact, we would always advocate contractors do seek out specialist advice.
There is, however, a line between engaging a provider for professional services, and engaging a provider to effectively run your company for you. While nobody would expect every contractor to have in-depth understanding of all tax legislation, company laws, and accounting rules; every contractor should understand what trading through a limited company means, what their director’s responsibilities are, and where the company monies are being spent.
From HMRC’s latest activity, 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 cause the MSC legislation to bite. On the basis that there is active promotion, active facilitation and then influence over the company. Part of that argument being that the portal is being used not simply as a mechanism for the company to provide information to its adviser, or even manage its own affairs; rather the portal is being utilised by the provider to allocate all funds as the provider sees fit (typically in the most tax-efficient way), leaving the contractor’s only ‘action’ as passive acceptance.
While we do not agree that the use of an online portal of itself should cause issues, we can certainly see a problem if a provider automatically allocates salary and dividend without consultation, and then simply directs payment without a contractor’s involvement or approval.
Finally, five (or so) questions to pose 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 flags HMRC will be keen to see hoisted -- for example do you need to approve all payments made by your company? And then similarly, answer the following five:
- Do you authorise all returns made to HMRC?
- Do you have control of your company’s income?
- Are you made to use a preferred bank?
- Do you only pay accountancy fees when your company is actively providing services?
- Do you 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.