MSC rules take effect as composite providers scramble into umbrellas

The managed service company legislation came into force on 6 April, and the sector it was designed to shut has spent the first days of the new tax year doing exactly that. Composite company providers, some with thousands of contractors on their books, have moved their workers to umbrella employment, to individually owned limited companies, or in a few cases have simply closed.

The rules, contained in this year's Finance Bill and applying to payments made from the start of the tax year, treat all money paid to a worker through a managed service company as employment income. Salary, dividends, loans and expenses beyond those an employee could claim are all subject to PAYE and Class 1 National Insurance. The IR35 test of whether the worker would have been an employee of the client is no longer relevant: if the company is a managed service company, everything is caught.

What changed in the final text

The definition published in the Bill is narrower than the December consultation draft in one respect that matters. A person who provides accountancy, legal or other professional services is not treated as involved with the company merely because they do so. That was the concession the accountancy bodies asked for, and they got it. What they did not get is certainty about where professional advice ends and involvement begins. HMRC's guidance says that an accountant who goes beyond advising into running the company, controlling its finances or promoting the structure as a product crosses the line. Practices that market limited companies to contractors are reading that passage carefully.

The transfer of debt provisions survived largely intact. Where a managed service company fails to pay, HMRC can pursue its directors, the provider and the provider's directors. The wider power to collect from anyone who encouraged or facilitated the arrangement, which could reach agencies and clients, has been deferred and will apply only to later payments. That has bought the recruitment industry a few months to decide how far it can safely go on dealing with these structures. Most large agencies have already decided the answer is not at all.

Winners and losers

The umbrella companies are the immediate beneficiaries. A contractor who was taking home 80 per cent of contract value through a composite will take home materially less through an umbrella, but the arrangement is clean, the employer is clear, and there is no debt to transfer. Umbrella providers report their busiest quarter since IR35 itself.

Contractor accountants offering individual limited companies are the other winners, provided they keep on the right side of the involvement test. The Professional Contractors Group, which supported the measure in principle, says the outcome is broadly what it argued for: the bulk-processed company is gone, and the genuine small business is left alone.

The losers are the workers who were never told what they had signed. Many contractors in composite schemes had no idea that they were directors of anything. Some are now discovering that they were, and that the company's tax affairs for earlier years are their affair too. The legislation is not retrospective, but the IR35 rule it replaces for these structures always applied, and HMRC has not said it will forget the past.

Whether the measure raises what the Treasury expects depends on how many of the workers now moving to umbrellas would otherwise have stayed in composites, and how many find their way to the next structure the market invents.