Taxman issues new laws on MSCs

The government has unveiled the final piece of draft legislation before it ensures managed service companies and their users pay their "fair share" of tax.

Published yesterday by HMRC and the Treasury, the proposals dictate managed service companies must, from April, pay the "correct level of tax" – namely PAYE and NI.

Incoming laws will allow both the PAYE and NIC debts of MSCs that go unpaid to be transferred to what the government described as "appropriate third parties."

According to HMRC compliance activity, "a number of different parties who could be involved in MSC schemes beyond the directors and the scheme provider" may be required to shoulder the debt.

'Third parties'

However the authority will seek to recover the debt first from the director, officer or associate of the MSC or the scheme provider.

Other third parties will only be considered if the debt cannot be recovered from these parties, the proposals state.

Potentially, "third parties" includes employment agencies, end clients, and then, a worker in an MSC who is not a director or officer of the company, but where they "could reasonably be expected" to know they were operating via an MSC.

Tax officials say the test to be applied is whether the person has," encouraged, facilitated or otherwise been involved in the provision by the MSC of the services of the relevant individual."

This means that debts cannot be transferred to anyone who has simply received the services of a worker operating through an MSC or unwittingly provided such a worker.

'Those who did not know'

The legislation, therefore, is "not intended to include those who did not know or could not reasonably be expected to know that they were dealing with an MSC," the government said.

An example cited in the consultation paper states: "An end client who told workers that they had no choice but to incorporate through an MSC or offered higher rates of pay to encourage workers to move to an MSC, would be within the scope.

"On the other hand, an end client who used workers from an employment agency, without knowing whether the workers were operating through companies or not, would not fall within the scope of the legislation."

'Sweeping power'

The Institute of Directors is less than the convinced at the Treasury's assertion that the "wholly innocent will not be caught."

Said its head of taxation Richard Baron: "This is a sweeping power for HM Revenue & Customs to collect whatever money they can, from whoever they can."

Under the new regulations, HMRC will recover tax from "one or more persons by the issue of a Transfer Notice, and set out the way in which that is to be done."

The government is inviting views on the legislation and regulations.

However the consultation is limited to only asking whether the draft proposals achieve the goal of stopping tax avoidance, as spelt out in a paper released alongside the pre-Budget report entitled 'Tackling Managed Service Companies.'

'Widely cast'

Lawyers at Lawspeed say the powers-that-be intend to "nail IR35 and expenses tax avoidance schemes," as a precedent to identifying the constituents of such a scheme "so that the net can be widely cast."

Their meeting with Treasury officials last month confirmed that the government is "determined" to implement the legislation by April 2007,"regardless of the need to amend the draft and the lack of time for agencies and MCs to adjust their affairs."

This suggests the lobbying efforts the Recruitment and Employment Confederation may go in vain, despite its insistence that more time would ensure greater levels of tax compliance -- something it said the government claims to take seriously.

Lawspeed's meeting also revealed the new legislation is not intended to penalise genuine umbrella companies that employ their workers and pay fully by way of employment income.

'Too much is grey'

However officials conceded the draft legislation may need to be altered to make this clearer – an admission that will hearten Marcia Roberts, REC's chief executive, who has said: "Too much is grey."

The ambiguity of the draft legislation is concerning service providers, end clients, employment agencies, individual workers -- and their advisers.

Roger Sinclair, legal consultant at Egos Ltd said: "The proposed legislation, both in relation to the transfer of debt provisions, and in the definition of a Managed Service Company Scheme, is less than clear, and a natural tendency to err on the side of caution for the sake of minimising perceived risk may have adverse effects on the whole contracting market.

"As a minimum, agencies and end-clients are likely to demand assurances that there is no Managed Service Company or Scheme Provider in the supply chain, for fear that they themselves might become exposed to unpaid tax and NI."

'Doesn't seem practical'

In addition, the April regulations will curtail tax relief for travel and lunchtime expenses, which have previously been the main perks of using an MSC.

Phil Richards, the chief executive of Manager Group, said: "An important consideration is that if umbrella companies were designed to be exempt from these rules then surely the government would have allowed 'composite and managed' companies to continue to allow workers to claim expenses for travel to and from a temporary contract site?

"It doesn't seem practical that there could be one rule for managed service providers and one rule for umbrella companies for travel expenses."

'Significant number'

Meanwhile, freelance tax advisor Nichola Ross Martin summed up the likely impact of the new rules in the long-term.

"HMRC estimates that 90% of the workers who would be affected will go and work for normal employment agencies.

"Their earnings will then be under PAYE and their travel rules the same as other agency workers," she said.

"A significant number of workers will resort back to the use of personal service companies and it is not clear how HMRC proposes to deal with the ensuing problems with the Intermediaries legislation."

The anticipated dash to incorporate has been predicted by freelance specialists including SJD Accountancy, the Professional Contractors Group and Bauer & Cottrell.

'No one really knows'

Yet Manager Group, a provider of services to limited company owners, says the impact of the new legislation will be known only when it has a chance to bed down.

In a statement, the firm said: "Whilst everyone involved in the freelancing market needs to be aware of possible outcomes, the reality is no one really knows what the final impact of the legislation will be."

Despite the caution, published estimates suggest imposing employment tax on users of managed service and composite companies will net the Treasury over £1billion in the next three years.

The new laws in final form will apply to any tax debt incurred from April 6 2007.

'Contractors may be tempted'

In a statement, Lawspeed reflected: "Whilst some [contractors] may be tempted to consider that there is time after 6th April 2007 to change their arrangements, there is in fact no time if potential tax liability is to be avoided."

Parties due to be affected by the incoming laws have two separate deadlines to issue a response to the government.

Comments on the legislation should be sent by March 2nd 2007; while comments on the regulations should be sent by April 30th 2007.

Please respond to: 'John Wrathmell, MSC Consultation, HM Treasury via the e-mail: [email protected].'

Editor's Note: Further reading here on Managed Service Company legislation.