Managed service company consultation closes with the industry braced for April

The consultation on the Treasury's plan to tax managed service company workers as employees closes early next month, and the shape of the responses is already clear: almost everyone accepts that the abuse the government describes exists, and almost everyone believes the proposed cure is drawn too widely.

The document, Tackling Managed Service Companies, was published alongside December's Pre-Budget Report. It describes a market that has grown up since IR35: providers who set up companies for contractors in bulk, run them centrally, and pay the workers through a mixture of low salary and dividends. Each worker is nominally a shareholder and director, but in practice has no involvement in running the company. The Treasury's view is that these are employment arrangements dressed as businesses, that the IR35 rule has proved unenforceable against them because there are too many companies to investigate one by one, and that the answer is to define the structure in law and tax everything paid through it as employment income.

Who is caught

The definition is the battleground. A managed service company, on the draft wording, is one in which a provider is involved with the company and the worker receives most of the payments for services. Involvement is defined broadly enough to include promoting the structure, influencing how payments are made, benefiting financially from the worker's services and providing insurance against the tax rules.

Accountants have spent the consultation period pointing out that most of those tests could describe an ordinary contractor accountancy practice. A firm that recommends a limited company, sets it up, runs the payroll and advises on dividends is involved in the company on any plain reading of the words. The Treasury says that is not the intention and that a person acting as a professional adviser will be excluded. The draft legislation will show whether the exclusion is worth anything.

The second concern is the transfer of debt. Where a managed service company fails to pay the PAYE and National Insurance due, the government proposes to collect it from the provider, from its directors, and, where the debt cannot be recovered there, from any person who encouraged or facilitated the arrangement. That is capable of reaching the agency that placed the worker and the client that used them. Agencies have read it and concluded that the safest course is to refuse to deal with managed service companies at all, which may be the point.

The composite providers

The businesses at the centre of the proposal are not waiting for the outcome. Several of the larger composite company providers have already announced that they will move their workers to umbrella employment from April, paying full PAYE and National Insurance on everything above expenses. Others are converting workers to individual limited companies with a proper accountancy service behind them, which the legislation is meant to leave alone.

The Professional Contractors Group has supported the aim of the measure while warning about the definition and the transfer of debt provisions. Its position, that genuine businesses run by their owners should be untouched, is the same one it has held on IR35 since 1999. The difference this time is that the Treasury appears to agree.

The rules take effect on 6 April 2007. With the Finance Bill still to be published, the industry has six weeks to restructure around legislation it has not yet seen. Nothing in the consultation suggests the timetable will slip.