In March HM Revenue & Customs sent income tax bills of up to £50,000 to 1000 contractors, after accusing their accountancy firm of breaking tax rules. One firm in question, Churchill Knight & Associates, is a specialist accountancy firm accused of breaching the Managed Service Company (MSC) law. 
This legislation is designed to ensure that contractors take responsibility for running their own limited companies, stopping company directors from paying typically lower corporate taxes and dividend taxes over employment taxes, if the company is controlled by another party - like an accountant or tax advisor. If HMRC categorises a firm as an MSC provider it deems all of its clients as users of an MSC and levies PAYE and national insurance to any income earned by the contractor’s businesses. 
 
Churchill Knight & Associates strenuously denied HMRC’s allegation. 
 
“ I don’t feel like it’s an attack on us. It’s an attack on the industry and on contractors who operate their own limited company.“ said Tom Edwards, operations director. 

But what is an MSC? 

A Managed Service Company, in the context of the definitions defined in the HMRC Employment Status Manual, refers to a service company that provides contractors with a composite company solution to manage their invoicing and accounting. 
 
In a composite company scheme, typically up to 20 contractors became non-director shareholders with the company managed by the scheme provider. The contractors were paid a low salary plus dividends in addition to claiming various expenses allowable under the corporate structure. This used to provide many financial benefits, since it avoided large amounts of national insurance and income tax that would otherwise have been payable if the contractor was paid entirely by salary. 
 
However, for a contractor to have used a composite scheme they must have been outside of the IR35 legislation or “not caught by IR35”. HMRC alleged that many contractors were operating using composite company schemes via Managed Service Companies, even though their status was certainly one of being inside IR35, claiming that many companies and contractors were ignoring the IR35 legislation. 
 
As HMRC could not effectively challenge all of the cases, new legislation was intended to remove the issue by forcing all MSC contractors to pay tax as though they were an employee of their client, effectively ruling all workers into an “IR35 caught” position. Any contractors genuinely outside of IR35 were expected to form their own limited companies, whilst those caught by IR35 would have to transfer to a PAYE type umbrella where all income was fully taxed. 
 
This legislation was highly effective, with thousands of contractors and service providers affected, ruling out manages service companies for contractors and increasing the popularity of umbrella company solutions. 

Might this affect you? 

HMRC’s allegations against Churchill Knight& Associates could be the tip of the iceberg with many more firms and their clients likely to be on the receiving end of an MSC probe in the future. However , clients of Effective Accounting should be reassured - Effective Accounting does not operate as an MSC at any level. 
 
In the unlikely event that any of our clients are contacted by HMRC with income tax bills relating to MSC allegations we would urge them to contact us immediately. 
 
Written by: 
Nicola J Sorrell - Effective Accounting 
Founder | Xero Champion | IR35 Expert 
Tagged as: For - Contractors
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