HMRC has provided new guidance warning contractors of the risks of using so-called ‘Managed Service Companies’ (MSCs).
What is the MSC legislation?
The MSC legislation was introduced in 2007 to target the use of contrived corporate structures, which provided (mainly) professional workers with the tax benefits of working via a limited company but without the responsibilities of running the company.
This paragraph from the recent guidance summarises HMRC’s view on how MSCs operate:
Managed Service Company Providers design and sell schemes that enable individuals to work through intermediary companies to end clients. The significant factor being the use of the intermediary company to lower the overall tax the worker pays. Managed Service Company schemes encourage and enable disguised employment.
The legislation is in Chapter 9 of the Income Tax (Earnings and Pensions) Act 2003, which you can access here.
The initial legislation significantly reduced the number of MSC providers, but it hasn’t been featured in contractor-related news headlines for over a decade.
In recent years, however, the tax authority has actively targeted a number of specialist accountants, who it claims are MSC providers.
In early 2022, clients of two mid-sized contractor accountancy firms started to receive ‘determination’ letters from HMRC, claiming back taxes for the 2018/19 tax year.
The letters followed HMRC’s claims that these firms were MSC providers exercising a great deal of control over their clients rather than accountants working at an arm’s length from their clients’ companies.
Over 1,000 limited company contractors are currently under investigation.
What happens if your limited company is deemed to be an MSC?
According to tax consultancy Qdos, which supports 100 contractors affected by the investigation, the average tax liability sought by HMRC is an eye-watering £57,000.
If your limited company is deemed to be a MSC, all of its income will be subject to standard employment taxes – national insurance and income tax.
When you consider the additional tax, penalties and HMRC interest, these additional costs could equal 40% of the income earned by the company since its formation.
Seb Maley, CEO of Qdos, says that the notoriously complex MSC rules can leave unsuspecting contractors with massive tax bills, often through no fault of their own.
The trouble with these rules is that freelancers caught up in MSCs aren’t motivated to avoid tax. Typically, they will have engaged an accountant that specialises in their industry and in forming limited companies.
It smacks of unfairness, but the fact of the matter is that if you fall into the trap of working through an MSC, the tax office could well demand up to 40% of everything you’ve earned through your company to date.
What you should do to keep clear of MSC providers?
To minimise your changes of being targeted for an MSC investigation, you need to ensure that your accountant isn’t an MSC provider – and they don’t have undue influence over the running of your limited company.
Make sure you know what the MSC legislation is and how to recognise an MSC provider.
According to the legislation and HMRC guidance, an MSCP will often:
Financially benefit on an ongoing basis from the services you provide to your clients. This refers more to fee structures based on your income than monthly accounting fees.
Influence or control how you provide your services.
Influences or controls how you receive payment (they may even have access to your company bank account).
Influences or controls your company’s finances or any of its activities.
You can read the recent HMRC Spotlight 67 guidance on MSCs, as well as our in-house guide to the MSC legislation, here.
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