Court of Appeal Acts to Close Managed Service Companies Tax Loophole

For those who provide their services personally, there can be significant tax advantages in interposing a corporate vehicle between themselves and clients who would otherwise pay them directly. Such arrangements are, however, frowned upon by HM Revenue and Customs (HMRC) and are likely be a great deal more difficult to operate following an important Court of Appeal ruling.

The case concerned a company that had established about 1,000 such interposing vehicles on behalf of a wide range of mainly professional people. Payments for the latter’s services were received by the vehicles, which employed them and generally paid them the National Minimum Wage. They were otherwise remunerated by the vehicles in the form of dividends. The intention was to achieve substantial savings in Income Tax (IT) and National Insurance Contributions (NICs).

After HMRC challenged those arrangements, the First-tier Tribunal, and subsequently the Upper Tribunal, found that the company was a provider of managed service companies (MSCs), within the meaning of Section 61B of the Income Tax (Earnings and Pensions) Act 2003. That meant that HMRC was entitled to treat dividends paid by the vehicles to their shareholders as employment income. Assessments to IT and NICs were accordingly raised against a number of shareholders.

In dismissing an appeal against that outcome brought by five of the vehicles that had been set up by the company, the Court noted that HMRC’s concerns related not only to loss of revenue but also to the risk that MSCs without assets may be put into liquidation or dissolved, leaving liabilities in respect of IT and NICs unpaid.

The Court found that the business that the Act was designed to catch was precisely the business that the company ran. It was engaged in promoting a situation in which workers provide their services through corporate vehicles, instead of directly to end clients. It provided shareholders with significant managerial assistance in operating such vehicles. In those circumstances, the company was undoubtedly an MSC provider and the vehicles it established were undoubtedly MSCs.