Contractors, new Managed Service Company guidance from HMRC is incoming

It has been 17 years since the Managed Service Company rules took effect, and still taxpayers can find it difficult to understand this legislation -- particularly whether they are in scope. This difficulty is very much down to the complexities of the various MSC arrangements.

Dual confusion

So if it’s not the MSC legislation itself which foxes contractors and other taxpayers, it’s the schemes, writes former tax inspector Carolyn Walsh, managing director of Oblako Ltd. Fortunately, there’s fresh help from HMRC on the way, but first – how did we get here?

The MSC legislation is designed to tackle a variety of tax avoidance schemes which are designed to allow clients to avoid paying PAYE through various corporate structures. The legislation therefore allows HMRC to treat any income paid through such structures as employment income, which inevitably raises a PAYE debt.

Scant regard

Nevertheless, managing Personal Service Companies (PSCs) is a lucrative business, and ‘facilitating and promoting the use of limited companies by workers’ continues to evolve in the freelance sector, with scant regard for the Managed Service Company legislation.

The services provided by a Managed Service Company Provider (MSCP) look legitimate enough, but scratch below the surface and it is all about the allocation of income to salary and dividends.

Where MSCPs differ to standard contractor accountants

Unlike a conventional accountant, an MSCP is generally in control of the money that flows through the bank accounts of most companies they manage. So, systems are in place to ensure that the money is easily managed. It is a huge task made simple by using a standardised system, which is essential for the MSCP but is not conducive to conventional accounting procedures.

The Revenue’s MSC legislation defines the types of arrangements that are in scope and therefore caught by the 2007 rules.

But to make the framework less opaque, I can disclose that HMRC is in the process of providing taxpayers with improved guidance on the MSC legislation, hopefully to enable them to distinguish an accountancy firm with potential questions to answer under the MSC rules (and so who may be an MSCP), from a conventional accountancy firm.

MSCs have evolved

As we know, there are five stated activities listed in the MSC legislation that define ‘involvement’ of the MSCP in a client’s business. However, these activities describe a relationship where it is assumed that the provider is using client companies, to process all income as business income, with no regard to clients paying the right amount of taxes. Yet not all clients are carbon copies of the type of clients we would have seen 17 years ago when the legislation was first enacted to tackle mass marketed tax avoidance schemes.

It’s true that an MSC provider will try to ‘control’ a client business’s accounting processes (usually via a portal as for convenience, this is how it copes with the volume of clients’ money that it attracts). Control is tied up in three of the five activities.

Services, and selling points

But time and again, we see that the rigid ‘services’ provision provided by MSCPs just doesn’t work for a genuine contractor-business owner. In fact, the accounting needs of a genuine, bonafide PSC contractor are very different to those of an individual who is concerned with being paid the highest possible take-home pay, which is the main ‘selling point’ of most MSC providers.

Their huge profits and that salary-dividend mix

But that’s not to say I’m siding with MSCPs here. These providers create schemes which use tax laws to gain an advantage that the government never intended. They typically have very few qualified accountants on board. At the same time, they generate huge profits from little more than marketing themselves as a ‘tax-saving’ service.

These providers claim that the low salary-high dividend mix -- used quite legitimately by conventional, bonafide PSCs -- is a ‘tax-effective’ model. And it is tax effective for business income, but this isn’t the case when it comes to income that perhaps should have been chargeable under PAYE!

Not totally understanding the reason for the MSC legislation and which types of arrangements it tackles, makes it tricky for taxpayers to recognise that an accountancy firm’s activities could indicate a breach of tax law.

A new (welcome) commitment from HMRC

Fortunately, HMRC has long ago confirmed that it is committed to improving guidance on the MSC legislation. It has also committed to highlighting the risks of using companies which masquerade as tax ‘agents’ but which bend tax rules with no concern for either tax legislation or their clients.

For this article, exclusively for ContractorUK, there’s even more fortunate news.

An HMRC spokesperson said: “The Managed Service Company (MSC) rules exist to help ensure people who work like employees pay tax like employees. We will be enhancing our guidance, to help people understand and identify MSC schemes, and what they should do if they’re unsure about the products they are being offered.’’

So as well as keeping watch of HMRC’s website for this new MSC guidance, contractors must remain alert to the dangers of ‘problematic’ tax advisories which appear to be genuine accountancy firms. These firms have caused tax liabilities to accrue for tens of thousands of unsuspecting taxpayers, many found in the contractor community who believed (and still believe) they were in total control of their business and making proper use of an accountant.

An MSC legislation anomaly…

The incoming, improved HMRC guidance on managed service companies is therefore not before time. And unusually for something tied to the MSC legislation, it’s something every party ranging from stoic HMRC and its unenvied inspectors to nervy contractors and jittery accountancy firms will all likely get behind.

Profile picture for user Carolyn Walsh

Written by Carolyn Walsh

With over twenty years’ experience in the sector, Carolyn assists freelancers, contractors, agency and umbrella company workers, interpreting tax legislation and guidance with a no-nonsense approach.
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