This article was first published on the Tax Journal.
The Court of Appeal has recently interpreted the MSC legislation more widely than expected, paving the way for HMRC to target arrangements previously thought to be low risk, as Frances Lewis, Ian Hyde and Kevin Barrow explain.
In this article, we look at the recent Court of Appeal (CA) decision in Christianuyi v HMRC  EWCA 474 (Civ) and how this is likely to impact the industry of accountancy advisers connected to the personal service company (PSC) world, their PSC contractor clients and, potentially, the staffing agencies or hirersthat referred the contractors to the accountancy advisers in the first place. In some ways, this represents a bigger threat to the PSC industry than the proposed IR35 reforms.
What is the MSC legislation?
The managed service companies (MSC) legislation, set out in ITEPA 2003 Chapter 9 Part 2, was introduced in 2007 to clamp down on the growing use by contractors of so-called composite companies. A composite company was a company through which contractorswould choose to supply their services, with each being a minority shareholder in that company. This allowed contractors to receive tax efficient dividends, etc. but without the individual having much, if any, of the administrative burden of runningtheir own company.
Realising the MSC legislation was the death knell for composites, many providers of composite solutions closed their businesses before the MSC legislation came into effect. Others moved to being accountancy service providers, offering standard packagedaccountancy services to contractors operating via PSCs. PSC contractors in the UK, who supply services to hirers, often through staffing agencies, still need specialist accountancy service providers to support them.
Of course, PSC contractors have also been the focus of the more publicised proposal to extend the off-payroll IR35 rules to the private sector. In HM Treasury’s Budget 2018 statement, HMRC estimated that the cost to the exchequer of non-compliancewith IR35 rules by PSC contractors will reach £1.3bn a year by 2023/24. On any basis, HMRC believes the scale of the use of PSCs in the UK is huge. The IR35 reforms will no doubt have a big effect. However, if HMRC chooses to usethe MSC legislation, rather than the new IR35 measures, it does not have to prove employment status to bring a successful claim.
It is therefore possible that HMRC will take the view that Christianuyi , and the personal liability risk it poses, may be more effective than the forthcoming IR35 changes in closing down the use of PSCs.
How does the MSC legislation work?
Where a company is set up to provide a worker’s services to a hirer and the MSC legislation applies, amounts paid to the PSC for those services that are not already subject to PAYE income tax and class 1 NICs (for example, dividends) are treatedas employment income and the MSC is liable to account for the PAYE and NIC.
Under the MSC legislation a PSC will be a MSC if, under ITEPA 2003 s 61B:
- its business consists wholly or mainly of providing (directly or indirectly) the services of an individual to other persons; payments from the MSC to the
- individual are tax efficient, e.g. outside IR35; 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.
Under s 61B(2), 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 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.
In other words, passing or failing an employment status test like the IR35 test is not one of the conditions in the MSC regime.
There is an exemption for accountancy services, provided that such providers ‘merely’ provide accountancy or legal services (s 61B(3)). It is thought that HMRC considers that accountancy advisers who market heavily to contractors andindustrialise the services offered will be doing more than ‘merely’ providing accountancy services. HMRC does not appear to consider that membership of a professional accountancy body will automatically guarantee exemption.
There is a similar exemption for staffing suppliers (s 61B(4)). However, where a staffing agency has encouraged a contractor to set up and work through a PSC, this exemption is unlikely to apply.
Who takes the risk?
Generally speaking, it is the PSC that faces the potential liability if the MSC rules apply. However, if the PSC or its director cannot pay, then HMRC can transfer the debt under the ‘recovery from other persons rules’ in ITEPA 2003 s 688A. The first port of call will be the MSC provider and its directors. If they are or become insolvent, and there is evidence that a referring staffing agency ‘encouraged or was actively involved in the provision by the MSC of the servicesof the individual’, then there is a risk that the tax debt could be transferred to the staffing agency and its directors. Although less likely, it is also possible that a hirer could face tax debt transfer if they encouraged contractorsto work through PSCs and to use certain advisers to effect this.
How has Christianuyi changed things?
HMRC guidance published when the MSC legislation was introduced appeared to limit its intended scope to targeting arrangements where the adviser was managing the PSC. The guidance seemed to recognise scope for accountancy service providers to marketto PSC clients, provided they did not manage their clients’ companies for them. In practice, this meant not linking their fee to the income generated by the PSC, not making decisions for the PSC, not managing the PSC’s bank accountand not agreeing contracts on behalf of the PSC.
Taking these factors into account, contractor market-focused accountancy service providers typically designed models intended to offer affordable accountancy services without taking over control of their clients’ companies. Until recently,it was thought that this would avoid the test of ‘involvement’. Some accountancy service providers also assumed that they benefited from the exemption for ‘merely’ providing accountancy services.
However, the court’s wide interpretation of the MSC legislation in Christianuyi appears to have given HMRC free rein to pursue PSCs and their accountancy advisers, causing great concern amongst accountancy service providers who target and provide packaged advice to PSC contractor clients. HMRC confirmed inSpotlight 32 of 1 May 2019 that these types of arrangements do not work and that it continues to open enquiries into users of such arrangements that include the provision of workers. Road haulage, healthcare and education seem to be sectors in whichHMRC is currently targeting the use of PSCs but there is no reason why its enquiries won’t extend to other industry sectors.
The PSCs in Christianuyi were all set up by Costelloe Business Services (‘Costelloe’). The issue that arose before the CA was whether the PSCs were MSCs and whether Costelloe was an MSC provider within the meaning of ITEPA 2003 s 61B. The FTTand CA interpreted the MSC legislation much more widely than originally expected. As a result, HMRC can now make the following arguments:
- For the MSC tax charge to apply, it is enough for the accountancy service provider to be in the business of promoting or facilitating the use by individuals of PSC structures and to have some form of regular charging structure for its services. In practice,any accountancy practice which actively markets to contractors will be at risk.
- HMRC does not have to prove, in addition, that the accountancy service provider promoted
The Upper Tribunal considered two additional areas.
Firstly, it considered the definition of an MSC provider as ‘a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals’, which was being interpreted differently by HMRC andthe appellants. The judgment confirmed HMRC’s view that if the answer to both of the following questions is ‘yes’, a person is an MSC provider:
- Does the person promote or facilitate the use of a company?
- Does that company (i.e. the PSC) provide the services of the individual?
Secondly, and perhaps most crucially, the UT decided that ‘influences’ and ‘control’ have a wider meanings than that expressed in the FTT decision. In this case, Costelloe influenced how payments were made to workers. This wasdone by use of a standard product causing the workers to receive wages and dividends instead of just wages. When workers buy such products, allowing the MSC provider to determine the amount to be paid as a dividend and to carry out the administrativesteps to effect this, it amounts to ‘control’. In addition, it was confirmed that ‘benefits financially on an ongoing basis from the provision of the services of the individuals’ could include a wide range of regular/instalmentcharging practices that many accountants would regard as perfectly normal. The CA agreed with the UT decision about the definition of an MSC provider, ruling that Costelloe ‘was undoubtedly an MSC provider and that the appellant’s companiesare undoubtedly MSCs’.
What effect is this decision going to have?
We understand that the earlier decision in this case has already been instrumental in leading some accountancy firms to withdraw from the PSC market. We are also aware that a number of contractors and their accountancy service providers have receivedinformation requests from HMRC regarding how their services were sold and operated.
HMRC is likely to scrutinise how accountancy service providers sold and operated their services, looking in particular at marketing messaging, initial sales conversations and registration, and whether IR35 status was taken into account; and looking indetail at how dividend payments were authorised. This appears to set up a (crucial) distinction between those who provide accounting services to a client who happens to be a PSC and those who provide services to clients because they are a PSC. Thisis a tricky point to prove.
In some cases, reliable information about the way in which the processes operated years ago may not be easy to recall, especially if processes have evolved over time. HMRC is also likely to request information from the PSC contractors themselvesand so the scope for conflicting responses is high.
What should advisers, staffing companies and end users do now?
The risk of MSC enforcement now looks greater than ever before, and the potentially large amounts of prior year tax and NICs at stake – and personal liability under the tax debt transfer rules – means this is an important issue for anyoneoperating in a situation where the MSC legislation could be relevant.
Anyone involved in using or supporting PSCs should review their arrangements urgently, including revisiting any MSC advice given to clients since 2007. Accountants should consider if and to what extent they market or marketed to the contractor industrysince 2007. In some cases, this may lead to a recommendation to cease offering services to contractors, including withdrawing targeted advertising from websites.
Anyone who finds themselves on the end of an MSC enquiry, including an ‘informal’ one, should consider their position carefully, as well as the technical arguments, the evidence available and the likely response of their PSC clients, beforeresponding to HMRC.
Staffing companies should review any referral or preferred supplier arrangements with accountancy service providers. Not all such arrangements will be caught but some may be high risk, especially if the staffing company has encouraged contractors to contractthrough a PSC and has referred them to a ‘preferred’ accountancy service provider.
End users who may have put in place arrangements involving PSC contractors and the use of preferred accountancy advisers, possibly with referral payments (or some other form of benefit) flowing back to the end user, should urgently review these arrangements.
Hirers and agencies should check whether there is any risk under contractual indemnities.