Income Shifting Legislation

Most contractors should be aware that in the 2007 Budget, HMRC significantly changed the definition of a Managed Service Company since the consultation document "Tackling Managed Service Companies" was published in early December 2006.

This article attempts to explain the definitions in a plain English and practical way to help contractors understand how the legislation could apply to them.

What is a Managed Service Company?

Essentially the definition applies to all contractors working via their own limited companies, who receive income subject to less tax than if they were employed and who use an 'MSC Provider'.

A PAYE umbrella company is not caught as they pay workers the same amount of money as if they were in employment.

Accountants working in a "professional capacity" excluded

The legislation states that companies providing legal or
accountancy services in a professional capacity are exempt from the definition of an 'MSC Provider'.

Contractors need to consider if their accountant provides their services in the context of a "professional capacity". If they do, the legislation does not apply to the contractor's limited company.

Recognising an MSC Provider

Contractors working via a limited company need to be able to recognise an 'MSC Provider' who is "involved with the company" under the published legislation.

According to the legislation there are five tests that define an 'MSC Provider' being "involved with the company" and of which only one has to be relevant for the
legislation to apply.

Contractors can look at the following practical elements to assess if an 'MSC Provider' is "involved with the company":

a) Benefits financially on an ongoing basis from the provision of the services of the individual.

An MSC Provider could be involved if they:

• Receive a percentage fee of the income of the Managed Service Company or individual.
• Receive a fee when the worker provides the services, and does not receive a fee when the worker does not provide the service.
• Invoices out for services of an individual and then pays this income to the limited company, less its administration fee.

b) Influences or controls the provision of those services.

An MSC Provider could be involved if they:

• Arrange the contracts for service between the MSC Provider and the staffing company/end-client.
• Are involved with the arrangement of the contracts for service, the negotiation of rates and/or terms of the contract.
• Are involved in ensuring the contractor attends the worksite or enters into any dispute resolution.

c) Influences or controls the way in which payments to the individual (or associates of the individual) are made.

An MSC Provider could be involved if they:

• Have control over the company bank account, or access to the company bank account, or makes any payments.
• Calculate Payroll, Dividend and Expenses from the income of the MSC, and then instructs the contractor on what to pay themselves from the company bank account.

d) Influences or controls the company's finances or any of its activities.

An MSC Provider could be involved if they:

• Calculate how much a contractor has earned from an invoice, and instructs the contractor on how much to pay themselves from their company.

e) Gives or promotes an undertaking to make good any tax loss.

An MSC Provider could be involved if they:

• Introduce a contractor , and/or their company, to an insurance, scheme, guarantee or any form of protection from the loss of the payment of tax that would result to a freelancer where they are challenged successfully by HMRC, e.g. IR35, VAT and PAYE insurance.

Conclusion

Contractors working through their own limited companies need to know if their accountant is supplying their services in a "Professional Capacity".

To do this, contractors should ensure that they:

1. Know their accountant and the services they provide.
2. Recognise what an MSC Provider is.
3. Accept responsibility for their limited Ccompany.
4. Instruct an accountant acting in a professional capacity.
5. Ultimately make the final decisions.

Thanks to Phil Richards from The Manager Group for contributing this article

Further MSC Resources

You can also access HMRC's July 2007 guidance (PDF) which fully defines what an MSC provider is, how to recognise one, and how such companies will be taxed.

Also worth a read is the PCG's in-depth coverage of the legislation here.

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