What is an MSC?
A Managed Service Company, in the context of the definitions defined in the HMRC Employment Status Manual, refers to a service company that provides contractors with a composite company solution to manage their invoicing and accounting.
What was a composite company?
In a composite company scheme, typically up to 20 contractors became non director shareholders and the company was managed by the scheme provider. The contractors were then paid a low salary plus dividends in addition to claiming various expenses allowable under the corporate structure.
This method of payment used to provide many financial benefits, since it avoided large amounts of national insurance and income tax that would otherwise have been payable if the contractor was paid entirely by salary.
Managed Service Companies and IR35
However, for a contractor to have used a composite scheme they must have been outside of the IR35 legislation - or not 'caught by IR35'. “IR35” is a piece of tax legislation announced in 1999, which took effect from April 2000.
HMRC’s intention was to tackle tax and National Insurance (NIC) avoidance schemes through the use of intermediaries, such as Partnerships or Personal Services Companies (PSC). Contractors often use the Limited Company as a PSC to obtain work either direct from an end client or via an agency. HMRCs’s view was that a large number of IT Consultants, Engineers, non-executive directors and “one man band companies” were often treated as self-employed when in fact they should have been treated as employees of the end Client. This was based on the terms and conditions that the Contractors worked under.
HMRC argued that if the agency or the PSC were removed, a large number of contractors would really be “disguised employees” who should be included on the client payroll and have tax and NIC deducted each month. The Government announced the IR35 “rule changes” which would took effect from 6 April 2000.
Lack of enforcement led to the MSC legislation
HMRC alleged that many contractors were operating using composite company schemes via Managed Service Companies, even though their status was certainly one of being inside IR35. They claimed that many companies and contractors were ignoring the IR35 legislation. Since HMRC could not effectively challenge all the cases, the new legislation was intended to remove the issue by forcing all MSC contractors to pay tax as though they were an employee of their client, effectively ruling all workers using the scheme into an IR35 caught position.
Those contractors genuinely outside IR35 were expected to form their own limited companies, whilst those caught by IR35 would need to transfer to a simple PAYE type umbrella where all income was fully taxed.
The legislation was very effective and thousands of contractors and their service providers were affected by the legislation, effectively ruling out managed service companies for contractors, and increasing the population of contractors using umbrella company solutions.