Managed Service Companies (MSC)
If you’re planning to work as a professional Contractor you need to make sure that you’re not using a ‘Managed Service Company’, otherwise you could find that you face a large Income Tax and National Insurance bill down the line.
In April 2007 the Labour Government introduced the Managed Service Company (MSC) Legislation which effectively put an end to ‘Composite Companies’ and forced Contractors to choose between (1) going into business with a Contractor Limited Company and (2) using an Umbrella Company to deal with contract billings.
- Composite Companies were designed and fully managed by ‘Scheme Providers’ who offered contractors a solution that combined;
- All of the benefits of a Contractor Limited Company (i.e. tax efficient dividends), AND
- All of the benefits of an Umbrella Company (i.e. fully managed solution, minimum admin etc)
The problem was that certain large Scheme Providers decided to ignore IR35 altogether which meant that thousands upon thousands of low level contractors (who were entirely Inside IR35) avoided paying tax and national insurance on contract billings. This led the HMRC to deem Composite Companies mass tax avoidance schemes which ultimately led to the introduction of the MSC legislation in 2007.
What is an MSC Scheme Provider?
An MSC Scheme Provider is an organisation that provides Managed Service Company solutions to freelance contractors. Without a Scheme Provider there can be no Managed Service Company.
A Provider is defined as ‘a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals’.
Before April 2007 MSC Scheme Providers ‘promoted’ Composite Companies. They marketed them to freelance contractors through the internet and encouraged Recruitment Agencies to refer business to them. They also ‘facilitated’ the use of Composite Companies as they made them easy to use therefore encouraging mass uptake.
With the MSC Legislation the Government targeted the Scheme Provider but was careful (after consultation) not to imply that those providing legal or accountancy services in a professional capacity were to be considered Scheme Providers, otherwise it would be difficult for accountants to provide accountancy services or company formation agents to form companies for clients.
The exemption that was introduced applies only to persons professionally qualified and regulated by a regulatory body. However, the mere fact that someone is professionally accredited does not prevent them being deemed to be a Scheme Provider; they will be a Scheme Provider if that go beyond providing professional advice.
Meaning of a Managed Service Company
In July 2007 after much confusion the HM Revenue and Customs helped to clarify the MSC Legislation with a set of guidance notes. The guidance notes list four essential conditions of a Managed Service Company:
- The Managed Service Company must provide the services of an individual to third party clients, AND
- The Managed Service Company must pay the contractor the majority of the money (i.e. >50%) received from the contractor’s client, AND
- Payments received by the contractor should be greater than they would have been if treated as employment income subject to Income Tax and Class 1 National Insurance, AND
- There must be an MSC Provider and the provider must be involved with the contractors company; ‘involved’ can include control, or just influence, of the company, its operations, or marketing. Interpreted strictly, virtually any supplier could be deemed to be involved
This guidance information helps to ensure that freelance contractors using Umbrella Companies are outside the scope of the MSC Legislation as all income is received in the form of salary and expenses. Therefore the income the contractor receives from an Umbrella Company is the same as any other company through which the contractor operates.
Detailed Summary of the MSC Legislation
A company is deemed to be a Managed Service Company if:
- It is administered, promoted, or influenced; by a 3rd party who does more than provide arms length legal or accounting services. Such 3rd parties are deemed to be Managed Service Company scheme providers (MSCP), AND
- The worker is paid (retains) more than they would get under PAYE, AND
- The worker’s remuneration (including any dividends) is more than 50% of the billings that they generate.
Technically expense reimbursements are not included the 50% detailed in (3), but anyone hoping to avoid the MSC legislation by paying themselves large expenses is probably being reckless. Some people have opined that such expenses could later be deemed to be remuneration.
The very wide working of (1) means that, technically a provider of professional Indemnity insurance would be an MSCP if a client’s business was influenced by the director’s desire to remain within the terms of its insurance policy. It seems to give HMRC the right to deem anyone they want to be an MSCP. HMRC’s approach seems to be that they will know a scheme provider when they see one; they claim they will not use the legislation unreasonably but do not want clever scheme providers to be able to avoid the legislation. If you want to avoid your company being deemed to be an MSC due to the influence of a supplier, you should consider, among other things:
Can I show that I am genuinely in business rather than just using a company as a vehicle for remuneration? Do I have a website, business cards., marketing strategy, etc
- Who controls the company bank account
- Who sets staff salaries (including my salary)? What is the basis for the salary chosen?
- Who determines which expenses to allow?
- Who sets the company’s strategy?
- Who determines how the company is administered?
- Debt Transfer & MSC Legislation impact on Agencies
A key part of the MSC legislation is that it allows the debts of an MSC to be passed to 3rd parties deemed to have benefitted from the MSC. These include not only the employees (contractors) and officers of the MSC, but also anyone or any business that may have influenced or induced an individual to join the company deemed to be an MSC.
If an agency refers contractors to a list of preferred suppliers, and those preferred suppliers provide an MSC, the agency would be caught by debt transfer rules. As a result of this most agencies are conducting compliance checks on providers, and many will only allow umbrella solutions onto their preferred supplier list.
In October 2007 HMRC gave agencies the welcome news that they would not be liable for debt transfer when a contractor uses a company (even an MSC) that they had engaged before contacting the agency i.e. the issue for agencies is largely restricted to new contractors who need their first contracting vehicle. In these cases, agencies can be at risk even if their policy is not to recommend any scheme; an individual recruiter, acting without the knowledge of the agency, even if acting in breach of company policy, could expose the agency to a potential liability.
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