What is a managed service company? - contractors listen up

The term 'managed service company' has been used to describe several limited company structures over the years, including umbrella companies. The most contentious and widely condemned model is where a third party company (the MSC) sets up a limited company on behalf of a contractor or group of contractors.

The MSC (more correctly, the managed service company provider, or MSCP) manages and retains 100% control over the company, collects fees due on behalf of each contractor and disburses the bulk of income in the form of tax-efficient dividends.

The actual mix of remuneration for each contractor working under an MSC will vary but most will also receive a small salary (normally the equivalent to national minimum wage) and tax free business expenses. Since the majority of income is provided as dividends however, the total National Insurance Contributions (employee AND employer) due to HMRC are considerably lower.

Many have argued that contractors working under such a scheme have an unfair financial benefit since they are able to reduce their total tax burden (through the use of dividend payments) but without accepting the added responsibility of running their own business - the MSCP is doing that for them. After almost 7 years in making. the government decided to step in and take action culminating in the eventual introduction of the Managed Service Company Legislation in April 2007.

The new legislation effectively ruled that where a third party organisation has direct control over a contractor's limited company, any payments due to the contractor must be made in the form of 'employment income' (i.e PAYE salary and business expenses, where allowable) - NOT dividends.

A key element of the MSC legislation was the introduction of the debt transfer rule which effectively permitted the transfer of any tax debts (accrued as a result of using an MSC) to the directors of the MSCP and also to organisations that had actively encouraged contractors to use an MSC (i.e a recruitment agency). At the time, most MSC providers changed their position almost overnight from a managed service company to umbrella company operating full PAYE taxes on contractor payments.

Although the MSC Legislation is now over two years old, many recruitment agencies are still unsure about debt transfer and continue to refer contractors to MSCPs. Some have introduced MSC questionnaires for contractors to complete before starting an assignment whilst others have set-up entire compliance teams to deal with the fall out of the MSC Legislation.

One thing to be sure of it that the government and HMRC will continue to monitor the situation closely, and whilst many payroll providers now claim to be compliant, it's up to contractors AND recruiters to decide for themselves whether they are working with an Umbrella or MSCP. For the avoidance of any doubt, you should be safe working with an Umbrella and you should be safe if a contractor's limited company is 'assisted' by a firm of accountants that DON'T exert control over that company (i.e they're not an MSCP).

Difference in payments:

Managed Service Company = small PAYE salary, expenses and dividends
Umbrella Company = large PAYE salary and expenses (no dividends)

Both a Managed Service Company Provider and an Umbrella Company retains full control over the contractor's limited company.

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Image: Day 215 by Hoggheff