This is a seminal case in the sense that it is the first to consider the extent of the Managed Service Company (MSC) legislation.
The case report from the First Tier Tribunal (“The Tribunal”) is therefore essential reading for those who are involved in providing a variety of ‘payroll solutions’, for those who are advising on them and perhaps those using them.
What is the Managed Service Company (MSC) legislation?
The MSC legislation was introduced in Finance Act 2007 due to perceived gaps in the IR35 ‘intermediaries’ legislation in relation to mass market promoters of intermediary companies.
The MSC rules supplement those IR35 provisions and bite where a Company is provided by a Provider who operates a standard service company model. If the rules do bite, they impose a charge to earned income on payments received by the individual.
The definition of a Managed Service Company is contained in section 61B of ITEPA 2003.
A Company (or a Partnership) is a MSC if:
- its business consists wholly or mainly of providing the services of an individual;
- payments are made to the individual and the amount of such payments is equal the great parts all consideration paid for those services;
- the manner in which those payments are made creates a reduction in tax when compared to the liability that would have been paid if those payments been treated as employment income; and
- a person carrying on a business of promoting or facilitating the use of companies to provide the services of (an “MSC provider”) is involved with the company
For the avoidance of doubt all of these conditions need to be met.
Clearly there need to be two protagonists. Firstly, one requires there to be an MSC – the company through which the individual provides services.
Secondly, there also needs to be a Provider “involved” with the MSC.
So what’s does ‘involved’ mean?
The second part of 61B explains all. However some of its contents are not completely helpful. It is unsurprisingly that this was the main issue stake in the case.
An MSC provider is “involved with the company” if the MSC provider (or an associate the MSC provider) meets any one of the following five conditions, namely whether:
- he is able to financially benefit (on an ongoing basis) from the provision of the individual’s services;
- he influences or controls the provision of services;
- he or controls way in which payments to the individual and made;
- he influences or controls the company’s finances or any of its activities; or
- he gives or promotes and undertaking to make good any tax loss
In this case, it was common ground between the Provider (“CBS”) and HMRC that CBS was a MSC Provider for the purposes of legislation.
The point of dispute was purely whether CBS was ‘involved with’ the individual taxpayers service Companies – in other words, was CBS involved with the entity through which the individuals provided their services to an end user?
Furthermore HMRC accepted that:
- CBS did not influence or control provision of services; and
- CBS do not give up promoting an undertaking to make good any tax loss
The case therefore can be distilled down to the discussion of the other three conditions. If any of these conditions applied alone, or in combination, then the provider, CBS, would be ‘involved with’ the individual companies and the full force of the legislation would be felt.
The Remaining conditions
What were we left with? Well, to recap, the Court had to consider the following remaining conditions:
- Does the MSC provider benefit financially on an ongoing basis;
- Does the MSC provider influence or control the way in which payments to the individual are made; or
- Does the MSC provider influence or control the Company’s finances of any of its activities
The Tribunal’s general approach
Importantly, the FTT rejected Counsel for the Taxpayers arguments that the MSC legislation should be considered narrowly and to address a specific mischief. He referred to the sponsoring minister’s statements in Hansard to identify what this might be.
However, the Court rejected this stating that such supporting material could only be used where the statutory languages is “ambiguous” as per Pepper v Hart.
Furthermore, the Court stated that once the business (CBS) was established as a MSC Provider then the rules should be applied widely. Secondly, that the burden of proof lay on the appellant to show that it was not ‘involved with’ with individual companies.
Did the MSC provider benefit financially on an ongoing basis?
The legislation did not provide a definition of the phrase “benefits financially on an ongoing basis“.
However, it was the Court’s view that it did. This was decided based on an examination of the fee structures (there had been several) over the years CBS ran its business.
A clear principle seems to emerge from the analysis. This is that if a fee is only received when a payment is received then that will probably fall foul of the rule. However, if a weekly or monthly fee is charged independently of the receipt of payments then this should be OK.
The earliest fee structure – which was a % charged on the payments which went through the arrangement – fell foul of this condition. This is not a surprise and one that had been acknowledged in internal docs by the business and its lawyers before changing the charging structure!
Subsequent fee structures tried to tie the fees to services such as a payroll run. However, in practice, multiple payroll charges in a month were levied despite the fact that no additional services took place. In effect, these charges were still inextricably linked to the payments from the services provided by the individual.
Did the MSC provider influence or control the way in which payments to the individual are made?
It is important to note that the meaning of ‘control’ here is not the tax definition. Instead, it is the natural meaning of the word that applies. The Court distilled this as meaning “the exercise of the power or the ability to command or direct.”
‘Influences’ means simply whether the person’s acts or omissions have an effect on the pay in which payments to the individuals are made and “it is not necessary that…the person… [has] the power to ensure or direct that the other person acts in accordance with their wishes”
In the case there were a number of ‘test’ individual companies. In the case of each Company, the client had been provided with a ‘tick box’ form to indicate how they wanted to be ‘paid’. In other words, how would they like their salary and dividends to be split.
One of these individuals had not expressed any wish. The Provider therefore decided to pay him minimum wage and provide the balance in dividends. Importantly, no advice was provided and there were no communications with the client to ensure that this was the optimum route – other than the fact this might generally be the most efficient way of paying someone (notwithstanding this and any other anti-avoidance provisions.) As the Provider determined the whole of his salary and dividend payments they were found to ‘control’ the way in which payments were made.
In other cases, the client had selected their split of salary and dividends on the form mentioned above. As such, it was found that the Provider did not ‘control’ the amounts determined to be paid as remuneration (ie the salary element).
However, it was found that none of the Directors in these cases had been involved in voting dividends on their Companies and it was established that the meeting minutes were a fabrication. As such, it was found that the provider determined how surplus funds were distributed.
As such, all the cases under consideration were deemed to fall foul of this condition.
Did the MSC provider influence or control the Company’s finances or any of its activities?
The Court also found that the Provider ‘influenced’ the finances and / or other activities of the individual companies as follows:
- Substantially all clients used the ‘preferred’ banking facilities and used it to pay the fees;
- The Provider was also left to pay the taxes of the individual clients. In many cases it withheld the cash to pay taxes for over a year and benefitted from holding substantial cash balances.
As such, it was found that the Provider ‘influenced’ the manner in which the Companies paid taxes.
It should be noted that it was only necessary for the Court to determine that one of the three conditions above applied. However, it found that all were in point.
If one reads the facts of the case, it is not a surprise that this particular provider was found to fall foul of the MSC rules. Tactically, one would expect HMRC to attack a relatively weak case. That said, it is perhaps a foregone conclusion this will be appealed. However, this lengthy and thorough judgement is helpful for both those operating ‘payroll solutions’, those providing advice and perhaps some of the Tribunal’s discussion will be useful for those considering using such a structure.
In addition, the MSC rules allow HMRC to transfer tax liabilities of the individual companies to the MSC provider itself. It is the case that HMRC are looking to apply such a mechanism in this case – thought it will be in a separate hearing.
If you, or your clients, are affected by this decision then please do not hesitate to let us know.