Managed Service Companies

In the Pre-Budget statement the Chancellor announced his intention to change the way in which freelance workers, who provide their services through ‘managed service companies’ (MSCs) are taxed. MSCs are currently used in various sectors including teaching, contract cleaning and healthcare.

The story so far

In 2000 the government introduced rules to tackle the provision of services through Personal Service Companies (PSCs). PSCs were designed to ‘disguise employment’ by placing an intermediary, usually a company, between the payer and worker. This minimised the amount of tax and National Insurance Contributions (NIC) due by paying that worker, predominantly by the use of dividends.

The government has admitted that MSCs are not easy to define but explain that MSCs differ from PSCs. In a PSC the worker usually runs the company and is often the sole director. There are various types of MSCs but in essence an MSC provider sets up the legal structures and the administration so that a potentially large number of workers receive payments for their services in the form of dividends.

Income received by the MSC is paid out to the worker in such a way as to minimise the amount of tax and NIC payable. The worker typically receives pay equal to the National Minimum Wage and the balance of the fee income, after the MSC organiser has taken its charges, is paid out by way of dividends.

HMRC’s view

HMRC take the view that ‘workers’ in MSCs are almost invariably not in business on their own account. However HMRC have encountered increasing difficulty in applying the PSC rules to MSCs because of the large number of workers involved and the labour-intensive nature of the work. Even when the rules have been successfully applied, an MSC can often escape payment of outstanding tax and NIC as they have no assets and can be wound up.

Forthcoming legislation

The government has therefore decided to remove MSCs from the PSC rules and introduce new rules from April 2007. The intention of the new rules is to:

• ensure that those working in MSCs pay tax and NIC at the same level as other employees. Broadly this will mean that all payments made to the worker will be subject to PAYE and NIC deductions
• alter the travel and subsistence rules for workers of MSCs to ensure they are consistent with those for other employees
• allow the recovery of outstanding tax and NIC from ‘appropriate third parties’.

What next?

The proposals are a recognition by HMRC that they do not have the resources to enforce the PSC rules across the country. It will be interesting to see if the government takes further steps to tackle the tax and NIC savings that can be made by using dividends.