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HMRC Cracks Down On UK Managed Services Companies

by Robert Lee,, London

12 February 2007

HM Revenue and Customs has published detailed draft legislation to tackle what it regards as abusive tax practices among 'Managed Services Companies' (MSCs), which are used by many workers to reduce their tax and national insurance (NI) costs.

In the 2006 Budget, the government announced that it would respond to evidence of significant growth in the mass-marketing of MSC schemes, which can be used to avoid paying employed levels of tax and NICs.

There are existing rules - the "Intermediaries legislation" - to ensure that the correct tax and NICs treatment is applied, but these rules are, according to HMRC, not being followed by MSCs in the "vast majority of cases". Tax officials say that this gives them an unfair competitive advantage over compliant businesses and workers, while they also point to evidence that many workers are entering into MSC schemes without understanding that they may be giving up employment rights.

Draft legislation published last week allows the PAYE (pay-as-you-earn) debts of MSCs to be transferred to appropriate third parties. These provisions were announced in the consultation document 'Tackling Managed Service Companies'. The legislation also enables these debts to be recovered from the directors of such businesses.

Accounting firm KPMG says that employment agencies are most likely to be affected, but the new rules could expose end users (the organisations which ultimately engage the services of the worker involved) to risks. KPMG believes that such firms will need to ensure that they have due diligence processes in place to monitor practices all the way along their labour supply chains.

An estimated quarter of a million workers - including teachers, nurses, construction workers, IT specialists and electrical contractors - use MSCs to manage their professional remuneration in a tax-efficient way. Operating through an MSC, the worker is treated as a shareholder. This means they receive a minimal wage (which is taxable and subject to national insurance contributions) and the remainder of their remuneration in the form of dividends, which are not subject to national insurance and attract a lower rate of tax than other forms of income.

The Treasury estimates that preventing workers from operating via MSCs could yield it as much as GBP350 million per annum.

“Whilst this is a welcome move to reduce the level of non-compliance in the sector, many MSCs are making genuine efforts to be fully compliant with the new legislation and they and other compliant businesses will be adversely affected by this legislation," warned John Chaplin, Director, Employment Taxes at KPMG.

“Many end users will be concerned that they will be forced to meet another organisation’s liabilities under these ‘debt transfer’ rules and will need assurances from their providers that this is not an issue. Employment agencies (who play an important role in a challenging recruitment market) are now faced with an additional burden in that they will have to provide these assurances to their clients," he added.

"Neither the agencies nor the end users will have control over how the MSC runs their business and yet they will now potentially have to pick up the MSC’s liabilities for non-compliance if it does not operate properly. They have a short time frame to evaluate which of these organisations are compliant and take action to minimise their risks before the legislation is enacted in two months’ time," Chaplin concluded.

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