An alternative form of company has become increasingly popular for freelance contractors since the introduction of the IR35 legislation in 2000 known as a Managed Service Company (MSC).
A Managed Service Company is usually a Limited company that has been set up by a third-party company (a Managed Service Company Provider) who retains corporate responsibility of that Limited company.
This allows them to receive minimum salary payments and have the remainder of the balance paid as a dividend although the actual company is owned and run by the service provider; a Managed Service Company Provider.
This structure has become a popular choice as the contractors benefit from paying lower tax bills and National Insurance Contributions and also have little corporate responsibilities.
The MSC Provider normally also performs company secretarial duties and provides basic tax advice.
In return for these benefits, the provider charges a fee for delivering the service.
The MSC provider will manage and retain 100% control over the company, collect fees due on behalf of the contractor and then distribute the bulk of the income through tax-efficient dividends.
In order to work within these boundaries, the workers must pass IR35 tests to allow them to collect dividend payments.
Both HMRC and the UK Treasury announced they needed to address the use of Managed Service Companies as they were concerned that those who were deemed to be ‘employed’ in the eyes of the law were using these structures as a form of tax avoidance.
The Social Security Contributions (Managed Service Companies) Regulations were launched in 2007 and removed many of the tax advantages for contractors working through them.
HMRC have grown increasingly frustrated with MSC’s as, when investigated, they were able to liquidate due to lack of assets and open up as a new company the very next day.
As a result of the MSC legislation, all Managed Service Company Providers now have to operate Pay-As-You-Earn (PAYE) tax correctly and deduct the relevant tax and National Insurance Contributions on all income paid.
The outcome of this is that the only advantage now of a MSC is that the contractor still has no corporate responsibility.
In order to reinforce this amendment in law, HMRC have been permitted to recover any underpaid taxes with the help of third-party companies.
In other words, if a contractor is found to have underpaid tax as a consequence of being involved in a Managed Service Company it is likely they may find a bailiff on their doorstep.