Running a business involves risk, as most freelancers and contractors know all too well. There are many ways to mitigate that risk, including good cashflow management and business development. One of the rewards for this risk is more tax flexibility than employees, and the potential for higher take home pay.
Wouldn’t it be great if you could keep the monetary advantages of business ownership but remove most of the risk? Unsurprisingly, people have tried.
Shortly after IR35 was introduced in 1999, Managed Service Companies became, as we say in 2015, “a thing”. The idea was appealing enough: allow contractors the tax benefits of running a limited company, but without the inconvenience or risk usually involved.
Managed Service Company (MSC) providers usually pooled contractors into groups to become shareholders of a “composite company”. Their earnings were collected through the company and each shareholder was paid through a tax-efficient mix of salary and dividends while the company bookkeeping, credit control and year end filings were all dealt with by the scheme provider with minimal input from the contractors.
This process meant MSC providers could take a cookie-cutter approach to tax compliance, and contractors joined the schemes in their thousands. Although MSC providers were ostensibly accountancy firms, the one-size-fits-all setup meant an accountant wasn’t usually needed to operate a scheme. The provider would take a monthly fee for their services, and in some cases would even cover any tax losses arising from late or incorrect filings.
As you might expect, taking away the risk but still expecting the reward didn’t fly with HMRC, and just seven years after Managed Service Companies took off, the Finance Act 2007 introduced new rules to make sure anyone working through such a structure was taxed as a vanilla employee.
- As the rules stand currently a company is deemed to be a Managed Service Company provider if:
They provide the arrangement as a paid-for service to the contractor
They decide how they deliver those services
They are involved with the contractor’s remuneration
They control the contractor’s limited company’s finances or activities
They promise to cover any tax loss
The rules passed in 2007 mean that if a contractor is caught using a Managed Service Company, HMRC can (in much the same way as if a contractor is deemed to be inside IR35) recover any tax they would have paid had they been subject to standard PAYE taxation.
When is your accountant more than an accountant?
Although providers as they existed at the height of the MSC boom have disappeared, the Managed Service Company rules still loom large over the contractor accounting landscape.
The best way to stay compliant is to steer away from providers who offer “company in a box”-type solutions. If HMRC believes an accountant is offering a standard product to all its clients (regardless of their individual circumstances), which handles the runnings of the company and / or mitigates financial risk, they could fall foul of MSC legislation even if they are not explicitly breaking any of the existing rules.
Experienced contractors who lived through the introduction of IR35 and Managed Service Company rules will always raise an eyebrow if an accountant or umbrella company promises a specific percentage take home pay, or offers to raise invoices and record expenses on behalf of the contractor. Raising invoices on behalf of a contractor is seen as having (in the words of the legislation) “control [over] the company’s finances”, and is a huge red flag to HMRC.
Many new contractors are disappointed to learn they cannot buy an all-in-one solution to remove the trickier parts of operating a limited company – but you can’t have the rewards without the associated risk.