Agencies implementing IR35 compliance processes need to be careful to ensure that they don’t accidentally fall foul of the Managed Service Companies legislation. If they do, the repercussions from a tax perspective are drastic, and akin to all their contractors being found ‘inside IR35’, irrespective of the actual status in law. Not only that, but the debt transfer rules mean the agency and/or their directors can be liable for the unpaid tax.
Traditionally agencies have avoided any debt transfer risk by ensuring they do not become “associated” with large contractor accountancy providers by way of any preferred supplier list (“PSL”). But under Off-payroll a new threat needs to be carefully considered where tax loss insurance products are being bundled and promoted with compliance offerings whereby the agency itself could become a managed service company provider.
Agencies and promoting tax loss insurance products
The Managed Service Companies Legislation (“MSC legislation”), which came into force in 2008, is designed to combat tax avoidance due to the promotion and facilitation of limited companies on a large scale. Whilst the legislation was originally designed to target organisations providing limited companies to contractors, there are provisions whereby recruitment agencies can also be considered a Managed Service Company Provider (“MCSP”).
Section 61B(4) and 61B(5) together with 61B(2)(e) of the Finance Act contains provisions whereby an agency could be considered an MSCP if it “gives or promotes an undertaking to make good any tax loss”. It is from here a more direct threat arises for agencies as it currently does for accountancy service providers.
Such companies facilitated by MSC Providers are considered MSCs, and payments received by individuals providing services through MSCs are subject to PAYE for income tax and NICs. This means a contractor working through an MSC could find themselves subject to the equivalent tax treatment of being found ‘inside IR35’ regardless of their actual IR35 status.
But most worryingly for agencies, where an MSC is unable to pay its tax liability, its debt can be transferred to third parties, including the company’s directors, the MSC Provider, and potentially the agency or end hirer in the supply chain.
Suffice to say, everyone needs to give the MSC legislation a very wide berth. But, how do you do that?
The legislative specifics and agency promotion
Chapter 9, section 61B(1) of the Income Tax (Earnings and Pensions) Act 2003 sets out the definition of an MSC (See technical section at bottom of the article), with conditions (a) to (c) that are easily met by a contractor who uses their own limited company.
The last part though, condition 61B(1)(d) is crucial, and revolves around whether there is an MSC provider “involved with the company”. For a contractors company to warrant MSC status, the involvement of an MSC Provider is required.
Section 61B(2) defines what constitutes an MSC Provider’s involvement, which has an injunctive list of items (a) to (d) which are based around the MSC Provider influencing and controlling the company, for which traditional accountancy firms would not be doing.
But, the last item, 61B(2)(e) is the crucial part. It highlights the issue based upon which HMRC may argue that the MSC Provider is caught in the net. This elephant in the room is the provision of giving or promoting an undertaking to make good any take loss.
Section 61B(4) is an exemption designed for agencies, which indicates that the conditions in 61B(1)(d) are not met “merely by virtue of carrying on a business consisting only of placing individuals with persons who wish to obtain their services”. But, 61B(5) then removes that exemption if the agency satisfies 61B(2)(e) – i.e. the making good of any tax loss.
In the context of the Off-payroll legislation, this means that recruitment agencies who are offering IR35 compliance services must be careful not to automatically give or promote tax loss insurance as part of their services, otherwise they could be considered an MSCP. Messages that would convey this could be things like “Insurance-backed”, “removes tax liability” or “guaranteed no tax risk”, and so on.
Agencies can of course choose to buy their own insurance policies, but they need to be careful not to tout them as some sort of guarantee to their clients as part of any IR35 compliance offering.
Insurance is not a silver bullet and can present MSC risk
Some who are new to the insurance market may view insurance as an alternative to robust compliance processes, but this would be foolhardy. Off-Payroll compliance isn’t an issue that can be simply circumvented via an insurance policy and it’s important to remember that firms cannot insure against the non-payment of tax, in the same way that you cannot insure against a speeding ticket.
All companies should of course have tax investigation insurance, which covers any investigation costs and liabilities required to defend an investigation. Indeed, this type of policy is heavily recommended in any instance.
However, firms must seek to ensure that the correct tax is paid, and insurance policies will rarely compensate where the claimant hasn’t fulfilled their own compliance obligations. Neither will an insurance policy remedy the stress and reputational damage that a firm suffers when being dragged through the tax tribunals.
How agencies and hirers can protect themselves
Adopting a compliance-led approach is the only way to meet the reasonable care requirement and offer the best protection in the event of an HMRC enquiry.
Providing compliance obligations have been diligently fulfilled, firms should wind up in the enviable position of never having an issue. As the old saying goes “prevention is better than cure.”
If a service offering is primarily insurance-led, then conduct further due-diligence and take professional legal advice, as this could present considerable danger from an MSC perspective.
Because of the risk of MSC, agencies are also advised to avoid using large accountancy firms who provide assessment services linked to tax loss products. These arrangements could prove questionable in the eyes of the MSC legislation, and potentially ruinous for all parties associated with the fallout.
Technical: MSC Legislation: Sections 61B and 61C
61B Meaning of “managed service company”
A company is a “managed service company” if—
- its business consists wholly or mainly of providing (directly or indirectly) the services of an individual to other persons,
- 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,
- 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
- 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.
- An MSC provider is “involved with the company” if the MSC provider or an associate of the MSC provider—
- benefits financially on an ongoing basis from the provision of the services of the individual,
- influences or controls the provision of those services,
- influences or controls the way in which payments to the individual (or associates of the individual) are made,
- influences or controls the company's finances or any of its activities, or
- gives or promotes an undertaking to make good any tax loss.
- A person does not fall within subsection (1)(d) merely by virtue of providing legal or accountancy services in a professional capacity.
- A person does not fall within subsection (1)(d) merely by virtue of carrying on a business consisting only of placing individuals with persons who wish to obtain their services (including by contracting with companies which provide their services).
- Subsection (4) does not apply if the person or an associate of the person—
- does anything within subsection (2)(c) or (e), or
- does anything within subsection (2)(d) other than influencing the company's finances or activities by doing anything within subsection (2)(b).
61C Section 61B: supplementary
- The Treasury may by order provide that persons of a prescribed description do not fall within section 61B(1)(d).
- An order under subsection (1) may be made so as to have effect in relation to the whole of the tax year in which it is made.
- In section 61B and this section, “company” means a body corporate or partnership.
- References in section 61B to an associate of a person (“P”) include a person who, for the purpose of securing that the individual's services are provided by a company, acts in concert with P (or with P and other persons).
- In section 61B(2)(e), “undertaking to make good any tax loss” means an undertaking (in any terms) to make good (in whole or in part, and by any means) any cost to the individual or an associate of the individual resulting from a relevant provision, or a particular kind of relevant provision, applying in relation to payments made to the individual or associate.
- In subsection (5) “relevant provision” means—
- a provision of the Tax Acts,
- an enactment relating to national insurance, or
- a provision of subordinate legislation made under any such provision or enactment.