Closing the tax door on Managed Service Companies

From April next year, the Government will put legislation in place to close what it regards as tax loopholes being taken advantage of by managed service companies (MSCs). An MSC is a form of intermediary company through which workers provide their services to end clients. In the draft legislation 'MSC' includes both 'composites' and 'managed personal service companies'.

In essence a scheme provider promotes the use of these companies and provides the structure to workers. The worker (although a shareholder) is almost invariably not in business on his own account and not exercising control over the company (he is not usually a director of the MSC). That control lies with the scheme provider who has ongoing involvement in the MSC, exercising financial and/or management control of the company.

The new rules will apply only to those within the definition of MSCs set out in the consultation. The Intermediaries legislation (IR35) will remain in place, unchanged, for personal service companies. The Government intends to remove MSCs from the scope of IR35 and is consulting on the legislation defining MSCs to ensure that it is targeted accurately.

What this means is that those people who provide their services through MSCs will receive their income net of Pay As You Earn (PAYE) and National Insurance Contributions. Sectors where workers are often employed through these structures include construction, information and telecommunications sectors, engineering, healthcare, teaching, contract cleaning, transport and the oil and nuclear industries. The change is expected to raise approximately £350 million in tax revenues in 2007/08.

Mike Warburton, senior tax partner at Grant Thornton said, "Many workers, particularly migrant workers, who are operating through such companies may not be aware that these rules might apply to them and be under the misapprehension that this is the way that all agency workers provide their services."

"There are obvious tax advantages in these sorts of arrangements, but with an MSC obliged to operate pay as you earn (PAYE) and deduct tax and Class 1 NICs on that income, the case for joining one of these structures now becomes much less attractive. I am concerned that many low income workers in essential services such as nurses and teachers will suffer at a time when they may have taken on large mortgage commitments."

"However, the good news is that those operating their own personal service company, such as an owner-managed business, will not be caught by these rule changes," added Warburton.

Workers in the construction industry face further bad news. The standard rate of deduction for construction workers will increase from 18% to 20% and, as widely expected, the higher rate of deduction will be 30%.

While the Chancellor may argue that this is just a matter of the timing of tax payments, lower paid construction workers could be in the position of suffering tax at source and having to reclaim tax at a later date.

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