IR35s and Managed Service Companies (MSCs)

For many contractors, working through a limited company and being able to pay themselves in dividends has been a sensible and tax efficient way of running a business. Indeed, over the years, the government has introduced incentives for self employed workers to work in this way.

However, by the 2000, the government became concerned that too many workers, who were not genuinely self-employed were, were setting up limited companies, and that they were being encouraged to do so by service company providers and employment businesses for whom such arrangements were also profitable. This resulted in the introduction of the IR35 rules in that year's Budget.

The effect of IR35 is to prevent limited company workers from paying themselves in dividends unless they are genuinely in business on their own. This is achieved by looking at the contractual and working relationship between the worker and the end user client and asking if that relationship is a self employed or employed one. Where the relationship is seen as an employer/employee one, PAYE must be applied to the fees after expenses.

The government now believes that too many workers, or their service company providers, have not applied the IR35 rules as rigorously as they should have done resulting in a loss of PAYE and Mational Insurance contributions to the Treasury.

To counter the loss of revenue duties, the MSC (Managed Service Company) rules were introduced on 6 April 2007. The new rules impose a PAYE liability on a personal service company in circumstances where a service provider has facilitated, encouraged or otherwise been involved in the provision of a managed service company. The rules are backed up by provisions which allow and underpayment of PAYE to be collected from the worker, or the MSC provider, or from an employment business or end user client thas has been actively involved in the promotion of the service company.

Since the rules were introduced, some contractors have decided to look for a permanent position and others have decided to join an 'umbrella' organisation with the assistance only of a normal accountancy service, the MSC rules do not apply and the profits of those companies may still be distributed in dividends. In these circumstances the IR35 rules must still be applied.

For further information and advice about IR35s and what they mean to you contact BTG Tax, part of the Begbies Traynor group and sepcialist tax advisors