What is the Managed Service Company (MSC) Legislation?

Previously the contactor was the sole shareholder and benefactor of a limited company and was paid a basic wage and the remainder in dividends, thereby avoiding paying large amounts of Income Tax and National Insurance contributions (NICs).

However, post April 2007 dividends can only be paid if your contract is outside IR35 and you are receiving payment through you own personal limited company. You must demonstrate complete financial and administrative control.

One of the most common forms are 'Composite Companies' where typically up to 20 contractors become non director shareholders and the company is managed by the scheme provider. The contractors are then paid a low salary plus dividends in addition to claiming various allowable expenses. This method of payment provides many financial benefits, since it avoids large amounts of NICs and Income Tax that would otherwise be payable if the contractor was paid entirely by salary.

However, the rules for avoiding tax in these companies are exactly the same as for other contractors: to use a composite scheme you must be outside of the IR35 legislation .

The government has taken action to tackle MSCs which are attempting to disguise workers who fall within IR35 legislation in order to avoid paying the correct level of tax and NICs

It is the responsibility of the MSC to correctly operate PAYE and deduct the necessary tax and NICs on the income. Historically however, when caught these companies simply liquidated, as they had no assets, and started up another company the next day. In order to stop this, the recovery of underpaid taxes and NICs is now possible from appropriate third parties, principally those behind the company operating such schemes including directors, shadow directors and connected or controlling parties.

Some companies still offer variations on these schemes so it can be confusing to a contractor to know what is legal and what is not. The simplest way to not fall foul of the law is: if you decide to work via your own limited company then you must run it yourself, rather than delegate control and key decisions to a third party supplier.

Further reading
What is a managed service company? A contractor's guide
Umbrella companies - promoting a level playing field