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Managed Service Companies (“MSCs”) are companies established by groups of individuals through which they provide their services to third party companies (as opposed to entering into agreements with those third parties directly). The perceived advantage of such an arrangement has been that the third parties pay fees to the MSCs gross (without deduction of tax or NIC) and the individuals employed by the MSC, although in receipt of a relatively small salary, have been paid the substantial part of their remuneration in the form of a dividend in their capacity as a shareholder in the MSC. Tax on the dividend has been at a lower rate than would have been the case had they been paid remuneration directly and dividends do not attract a liability to pay national insurance contributions.
The Government was unhappy with these arrangements because of what they believe to be significant loss of income tax and national insurance contributions. In December 2006 and February 2007 the Government published details of a new regime whereby all payments received by employees in respect of their services provided through an MSC would be treated as employment income subject to PAYE and NIC on the basis that the reality of the relationship between those “employees” and the third parties to whom their services were provided was a relationship of employer and employee.
The reason why the Government published these proposals is not only the perceived loss of tax but also its failure to stop MSCs functioning in this way by using legislation introduced in 2000 aimed at countering the use of personal service companies to avoid or defer the payment of income tax and NICs. Personal service companies (sometimes referred to as IR 35 companies) were more often than not owned entirely by their principal employee who through the personal service company furnished his/her services to one or more third parties in return for the payment of a gross fee in circumstances where the HMRC claimed the reality was that there existed an employment relationship between the third party and the employee. In other words the personal service company was no more than a “conduit” or, indeed, a nominee. The HMRC however were not entirely successful, not least because of the length of time it took them to analyse the arrangements and to attack them successfully and often by the time that the HMRC had completed its analysis and established its claims the MSC had closed down and since it had no assets there was nothing against which HMRC was able to collect PAYE and NIC assessed.
An MSC is defined as a scheme or arrangement that contains the following four elements:
| 1) |
the services are provided by companies to third parties; |
| 2) |
most of the money earned by the “employee” for the services provided through the MSC is paid to the employee; |
| 3) |
there is someone often called the “scheme provider” who exercises control over the company’s finances or general management; and |
| 4) |
employees whose services are provided by the MSC do not exercise control over it. |
Given the problems that the HMRC has had in the past in recovering PAYE and NIC liabilities against MSCs the legislation introduced gives it power to recover deemed tax liabilities from the third parties to whom services have been supplied where it considers the debt to be “irrecoverable” from the MSC. At that point, once a “transfer notice” has been served, the HMRC may seek to recover the tax outstanding from the MSCs directors, office holders and associates and the “scheme provider” or, if recovery against them is impossible, or cannot effectively be obtained, anyone who has “directly or indirectly encouraged, facilitated or otherwise been involved in the provision by the MSC of the services of the individual”. These “facilitators” may include the third party to whom services have been provided where that third party knew, or ought reasonably have been expected to know, that they were dealing with an MSC.
HMRC claims that there exist protections which will avoid the legislation being unfairly applied but there is clearly uncertainty in this area and little doubt that if the company knows it is using employees whose services have been provided by an MSC then there is the risk that additional tax liabilities may be incurred by the third party where those tax liabilities have proved to be irrecoverable from the MSC. Companies should therefore be wary of entering into arrangements of this kind with intermediary organisations otherwise they may find themselves exposed to tax and NIC liabilities.
Paddy Grafton Green
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Simkins' early warning bulletins are for general guidance only. Legal advice should be sought before taking action in relation to specific matters. Where reference is made to Court decisions facts referred to are those reported as found by the Court. Please note that past bulletins included in the Archive have not been updated by any subsequent changes in statute or case law.
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