The Government has published draft legislation to crack down on managed service companies. The purpose of this article is to explain what these companies are, and the effect of the new rules on their tax position.
What is a managed service company?
Simply put, it is an intermediary company through which workers supply their services to clients. A worker may wish to operate through a company structure, but lack the time and resources to arrange this efficiently. However, there are some packaged, ready to use companies through which the worker may supply his services. He pays a fee to the provider of the packaged company, and buys shares in the company. In return, the provider takes care of all the administrative and regulatory requirements of running a company. As for remuneration, the worker is paid salary and dividends often in a combination likely to be the most tax-efficent.
An MSC is different from a personal service company. In the latter case, the worker is in business on his own account. He runs the company, and is most likely the only shareholder. A worker operating through an MSC does not have such control over the company. That remains with the provider. The IR35 provisions still apply to personal service companies, but MSCs will be taxed under a separate regime to be enacted by the Finance Act 2007.
Why the change in the law?
MSCs (together with personal service companies) are currently within the intermediaries legislation for tax and NIC purposes. The rules treat payments received by individuals providing their services through intermediaries as earnings from employment, provided certain conditions are met. The test is applied on a case by case basis.
In December 2006, the Government expressed concern that the intermediaries rules were not being followed by MSCs, resulting in large-scale tax avoidance by these companies.
The Government's way of dealing with this issue is to draft an effective definition of an MSC, so that if a company falls within that definition, then the MSC rules introduced by the Finance Act 2007 apply. This is a more efficient way of tackling the problem than operating on a case by case basis, as is the case under the intermediaries legislation.
Overview of the MSC rules
The Finance Bill currently provides the following definition of an MSC:
(1) A company is a “managed service company” if—
(a) its business consists wholly or mainly of providing (directly or indirectly) the services of an individual to other persons,
(b) payments are made (directly or indirectly) to the individual (or associates of the individual) of an amount equal to the greater part or all of the consideration for the provision of the services,
(c) the way in which those payments are made would result in the individual (or associates) receiving payments of an amount (net of tax and national insurance) exceeding that which would be received (net of tax and national insurance) if every payment in respect of the services were employment income of the individual, and
(d) a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals (“an MSC provider”) is involved with the company.
If a company satisfies the above conditions, the intermediaries rules do not apply, and the MSC rules govern its tax position.
So what are these MSC rules? First, there is a deeming provision. All payments received by a worker supplying his services through an MSC are deemed to be employment income. PAYE and NICs must therefore be deducted in respect of those payments. Even if the worker receives his income in the form of dividends, they are still subject to PAYE and NIC.
There are also rules for the transfer of PAYE and NIC debts. If the MSC fails to pay the PAYE and NICs, the debt can be transferred to the company director and the scheme provider. It could also be transferred to a third party where the party in question is a person who, directly or indirectly, has encouraged, facilitated or otherwise been actively involved in the provision by the MSC of the worker's services. There was concern that this provision could catch persons who did not even know of the existence of the scheme, but the provision has been drawn tightly enough to prevent that.
When do the rules come into force?
Budget Note 46 states that the provisions for deducting PAYE take effect from 6 April 2007. The equivalent provisions for NIC will take effect from a date to be appointed by regulations made under the Finance Act 2007.
Provided Royal Assent to the Finance Act 2007 is given on or before 6 August 2007, the debt transfer provisions take effect as follows:
- on or after 6 August 2007 for debts incurred for directors or office holders of MSCs and MSC providers (and associates of those persons), and
- to debts incurred on or after 6 January 2008 for other persons.
It is not really clear what the above means. The Finance Bill does not seem to shed more light on this, providing simply that the rules are deemed to come into force on 6 April 2007. I will run through the Bill again to see if I can make sense of the commencement provisions.