Managed Service Company Legislation

In the 2006 Budget Statement the Chancellor announced that it would consult on action to tackle Managed Service Companies (MSCs). Draft legislation was issued in December 2006, and following consultation became law on April 6th 2007. MSCs are corporate structures (often referred to as Composite Companies or fully managed Limited Companies) through which workers provide labour services.

In contrast to Personal Service Companies, workers in MSCs are not considered by Government to be in business on their own account and the underlying nature of the contracts in which they are involved is one of employment. It is a long-standing principle that the tax treatment of income is determined by its nature – that is, income which is properly employment income should be taxed as such. Consistent with this principle the Government has sought to ensure that even if an individual is working through a company, but the underlying nature of the contract is one of employment, tax and national insurance contributions should be paid at employed levels.

Government believes that existing IR35 legislation are not being followed by MSCs which are therefore avoiding employed levels of tax and NI by distributing a large proportion of employment income as a dividend payment. The MSC legislation effectively removes MSCs from the scope of the IR35 legislation and applies a tax treatment to those working in MSCs which means they will pay tax and national insurance contributions at the same level as other employees barring them from any benefit associated with dividend payments. The legislation has not provided a definition of a managed service company. Instead Government has targeted this legislation at the Managed Service Company providers themselves. The definition has been broadly drawn and there is much debate and confusion over whether accountants in professional practice are exempt.

In effect if a limited company (or personal service company) is supported by an MSC provider, they will be a deemed as an MSC. The danger of this approach is that many legitimate limited companies may unwittingly get caught at some future date if their service provider is judged by HMRC to be an MSC provider. Any dividend that had been paid since 5th April 2007 would become subject to employment rates of tax and national insurance. HMRC is able to add penalty charges and interest back dated to the day the tax and NI should have been paid. And the sting in the tail is that the government has also extended the transfer of debt provisions to allow them to pass the debt of any unpaid taxes to third parties (MSC providers, Recruitment Agencies and End Clients).

In our opinion it is highly likely to be litigation between HMRC and those service providers that do not pay contractors purely by way of employment. Therefore we are advising contractors not to use the limited company structure until the legislation is clarified through the courts and is unambiguous.