The following articles cover;

1. Disguised Remuneration Schemes
2. Involvement as defined in MSC legislation
3. The MSC legislation
4. Managed Service Company Providers



Tax Risks Don’t Always End at MSC and IR35

When agencies and other hirers made it a policy to stop using limited company contractors after the Off-Payroll Working Rules, otherwise known as the IR35 Reform, hit in 2017 and again in 2021, many contractors were paid via umbrella companies instead.

Sometimes, the umbrella companies paid those workers around the same level of net pay as when they were company directors drawing a low salary and dividends. That can’t be right surely!

It wasn’t right, this phenomenon could only be achieved by using a tax avoidance scheme, and when each type of scheme is deemed defeated by HMRC, contractors who may have had an issue with IR35 or MSC legislation in the past, would find they have another issue; they’ve unknowingly used what is called a disguised remuneration scheme. 

Legislation was put in place to tackle tax avoidance schemes that masquerade as genuine umbrella companies. These companies deduct the correct amount of PAYE from a worker’s employment income (basic pay plus holiday pay). HMRC focuses on recovering the unpaid PAYE from the workers, and it relies on legislation which provides that, if an employee knows the employer is not deducting tax and NI contributions, i.e. PAYE, at the correct level, the employee remains liable to pay the shortfall over to HMRC, plus penalties and interest.

We discuss MSC risk in the following articles but workers who have been paid via an umbrella company can assess the likelihood of there being another or a further risk, by reflecting on how they were (or are) being paid.

Does the umbrella company pay a small amount of taxable pay and another payment which is termed, an advance, expenses or anything other than pay?

Workers can also log into their personal tax account and see the level of income that has been reported to HMRC, if it is less than the income that was earned, part of the income has been hidden from HMRC, having paid it to the worker as untaxed income.

Please get in touch for more guidance and information, if you think you may have an MSC risk or have any other type of PAYE liability due to the type of provider that was or is involved in paying you. 

Is an MSC Provider Involved?

MSC legislation is possibly more of a minefield than IR35 legislation because it relates to the use of a specific type of accountancy service, rather than the manner in which a worker/director provides services to clients.

This is partly because HMRC was careful to exclude genuine accountancy firms from the relevant legislation, even though many of the service provisions are exactly the same, e.g. setting up limited companies on behalf of clients, running the company payroll, filing annual company returns.

In order to determine whether a worker/director is caught by MSC legislation, he or she must somehow know whether their accountant is deemed to be an MSC Provider (MSCP). See below for a link to HMRC guidance on MSC legislation. For the average taxpayer it is an almost insurmountable task, not helped by the fact that all MSC Providers vehemently claim that the firm is an accountancy firm and not an MSC Provider.

There are telling differences between an MSCP and an accountancy firm, for example, often an MSCP will manage the funds being paid to the worker/director’s company by an agency or client. Also, due to the high volume of limited companies being managed, the MSCP tends to force those directors to use a 'standardised product'. In short, very little choice is given with regard to the level of service that will be provided, nor is any tailored advice available.

So let's look at the basics; in the official guidance, https://www.gov.uk/hmrc-internal-manuals/employment-status-manual/esm3520 HMRC states,

‘Where it is clearly a standardised product constituting the MSC Provider being involved with client companies, it (HMRC) will take the starting view that all client companies are MSCs. The onus will then be on the individual companies to demonstrate no involvement.’

What does involvement mean?

“Involved” is defined in the legislation by reference to any one of five activities relating to the ‘accountant’ and the worker/director’s company.

1. The accountant’s fee structure is directly related to the financial activity of the company
2. There is evidence of undue influence or control over the worker/director and the company, e.g. determining the terms under which the worker provides their services or is to be remunerated
3. The distribution of profits conform to a standardised product over which the worker as director has little to no control or influence
4. The accountant is able to influence or control the company’s finances or any of its activities
5. The accountant offers insurance against the tax/NIC liabilities arising under the MSC legislation, IR35, or any other provision of the Tax Acts or National Insurance legislation.

Generally, only the third and fourth activities apply, and this is particularly so with the providers and taxpayers currently caught up in the latest MSC cases. If these tests are not satisfied, then MSC legislation simply cannot apply.

For anyone who has received a letter from HMRC which mentions MSC legislation, this is solely because HMRC’s opinion is that their accountancy firm falls within the definition of MSC legislation, and as the guidance says, HMRC will take the starting view that all companies that have received an accountancy service from that firm will be an MSC. And it's up to the taxpayer to counter that opinion using the relevant appeal process.

Why is this an issue?

MSC means a managed service company, which takes the worker/director’s company outside IR35 legislation, simply because it is not considered to be a personal service company (PSC). MSC legislation provides that the worker/director's company must treat any income generated under PAYE, it has to be said, under less favourable terms than if IR35 actually applied to the worker/director’s contracts.

If your accountancy firm refers to there being a live investigation which is being challenged, it may be obfuscating or muddying the waters, because when HMRC has notified all companies that they are considered to be MSCs, the investigation has lead to a high court decision that the firm is a MSC Provider, and the accountancy service provider, having been involved in the investigation will obviously know that.

What Kind of Magic Trick Turns a PSC into an MSC?

The question is why did HMRC decide that it needed a trick up its sleeve anyway? 

The answer is that a few contractor accountants dreamt up the concept of the ‘composite company’ as a means of avoiding IR35 legislation back in the year 2000 and the counteraction was inevitably sought and on the way.

In 2007, MSC legislation identified a certain type of contractor accountant, meticulously listing a set of criteria that described their mode of operation perfectly. Result – composite companies disappeared overnight, save for a few firms that clearly didn’t get the memo, or chose to ignore the new rules regardless of the risks to the contractors that pay their fees.

These contractor accountants became umbrella companies, henceforth employing workers and providing access to the tax relief that is (or rather was) available to all employees. This was until 2016 when HMRC overhauled the tax system and disallowed the process by which employee tax relief was handled.

The only option for the umbrella companies to remain viable (and in business) was to become contractor accountants again. It helped that agency legislation had been overhauled in 2014, and it appeared that a back door had been left open for workers who supplied their services via a personal service company (PSC), who could then avoid being paid on an agency or their hirer’s payroll.

However, HMRC expected worker/directors to operate IR35 when working on the majority of agency contracts, but of course the MSC Providers did not make that known, rather they provided a service that encouraged directors to ignore IR35 completely.

This is why IR35 is sometimes referred to as the Off-Payroll Working Rules, and it's one of the reasons the IR35 Reform was introduced, leading contractor accountants with no choice than to go back to providing umbrella services, as we saw in 2017 and then again in 2021.

Contractor accountants often set up a separate accountancy practice, because accountancy firms in general are not caught by MSC legislation, but even though each worker/director set up an individual limited company, this type of provider consciously or not, slipped into the provision of a standardised service to the contractors on their databases, often due to the pressure of providing accountancy services in such high volumes, which satisfied the relevant criteria for the legislation to apply.

This was an inexcusable error in judgement in my opinion, as was paying referral fees to agencies and clients, along with advertising the fact that contractors would take home more money i.e. save tax. I'm not saying that accountants don't market their services, but genuine accountants simply do not act in this way.

Assuming a contractor accountant ticks the boxes for being deemed an MSC provider, there is list of criteria which magically turns a PSC into an MSC (remembering that there is no legal definition of a PSC, but there is one for an MSC, which has been challenged and proven in a number of court cases).

The legal definition;

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.

Or in simpler terms-

1. The director personally generates most of the company income by working for clients/hirers and issuing invoices from his/her limited company.
2. The director is paid the majority of the amount invoiced by his/her company.
3. The director receives more net pay than if he/she had been paid as an employee of the client or hirer.
4. The 'accountant' is deemed to be a Managed Service Company Provider.

It’s very clear to see that the issue is not actually with the PSC, which is perfectly entitled to invoice clients for the director’s services, and to draw most of the turnover as salary and dividends, unless IR35 applies when most of the turnover must be treated as employment income (salary). None of this is an issue, until a contractor accountant which is deemed to be a Managed Service Company Provider enters the picture.

Therefore, in order to avoid any risk, or if the worst happens, to appeal a notice of decision from HMRC under MSC legislation, the trick is to not base your argument on your company, how it operates or even your employment status. You must ask the contractor accountant used for clear and concise evidence that it is NOT a Managed Service Company Provider and provide that information to HMRC, while for safety's sake, gathering proof that the evidence provided is actually correct.

If that proof is not forthcoming, the next line of defence is to prove the MSC Provider was not involved in your company, within the definition of MSC legislation, see previous article.

Identifying an MSC Provider

Specific behaviours identify the involvement of an MSC Provider which leads to an MSC risk for company directors. So to help in determining MSC risk, the following can indicate that the accountancy firm used, could be treated as an MSC Provider by an HMRC employment status team. In short, MSC risk means that all company income would be retrospectively deemed to be employment income.

• You paid a weekly/monthly fee to the firm, which was deducted from the income paid to you via the potential MSC Provider, and when you stopped working for the agency/client that hired you, even while on holiday, you stopped paying the fees.
• If you did stop paying fees, an MSC provider would not send an invoice for accountancy services, would not file your company or personal tax returns, would not advise you further and most importantly would not have sent you a letter of disengagement; it would have simply ceased contact with you.
• The firm may have closed your company or allowed it to be struck off at Companies House, without generating a profit & loss statement or reporting the income that you received via a company or a personal tax return.
• You are, or were, not required you to sign off (agree to) your company accounts, you would not have been shown your company balance sheet or received any professional advice concerning your company’s financial position.
• Your company may not have an employer PAYE scheme under which your director’s salary is or was reported (you can ascertain this by logging in to your personal tax account and looking at the relevant tax years).
• You did not determine what level of salary you draw as a director, nor have any input into the financial affairs or future of your company.
• If you had decided to move your company accounting to a new firm, a potential MSC provider would probably not have replied to a professional clearance letter.

This list describes only seven scenarios in layman’s terms, but HMRC will frame its argument around what is known as MSC legislation, which is found at Chapter 9, Part 2, Income Tax (Earnings and Pensions) Act 2003

It is worthwhile to take a look at this legislation plus the guidance at ESM3505 which is a little easier to understand. Further guidance will be publish this year, and a link to it will be posted here.