This note discusses the introduction in 2007 of the 'Managed Service Companies' (MSCs) legislation, which sought to prevent the exploitation of this corporate form for tax avoidance.Jump to full report >>
Over the last twenty years there has been an increasing tread for workers to provide their services to clients using an intermediary company. There are two broad types:
Personal Service Companies (PSCs): the company sells the services of the worker, who is usually the director of the company as well. The worker is paid a salary, and can receive dividends as a shareholder of the PSC.
Managed Service Companies (MSCs): the company sells the worker’s services, but the worker has no control over the business. The company is run by a scheme provider, supplying these generic company structures to workers, and administering the schemes. As with PSCs, workers are paid a salary – often set at the National Minimum Wage – along with reimbursed expenses and dividends.
Individuals providing their services this way can make significant tax savings by taking their remuneration in the form of dividends rather than a salary, as this type of income is not liable to National Insurance contributions, and, prior to reforms in 2016/17, could be received tax-free by basic rate taxpayers.
In April 2000 the Labour Government introduced legislation to ensure that income earned by a PSC when the individual was, in effect, being employed by their client, would be taxed as earnings. These statutory provisions - the ‘intermediaries’ legislation – are often referred to as IR35, after the number of the press notice when this measure was first announced.
Over the next few years HM Revenue & Customs found considerable difficulties to using the IR35 rules to tackle tax avoidance by MSC workers, whose numbers had grown substantially over this time: from around 65,000 in 2002/03 to at least 240,000 in 2005/06. In December 2006 the Labour Government published a consultation paper, alongside the Pre-Budget Report, with proposals to remove MSCs from the scope of IR35 and tax MSC workers as employees. Following responses to this document, the Government confirmed it would proceed with these changes in Budget 2007. Provisions to determine the income tax treatment of MSCs are contained in the Finance Act 2007 (section 25 & schedule 3). The new rules came into force on 6 April 2007. At the time it was estimated would raise £350 million in 2007/08, rising to £450 million in 2008/09.
The introduction of this avoidance legislation appears to have dealt with the concerns over the use of MSCs – although there have continued to be developments, both in market practices and in legislative requirements regarding the classification of individuals as an employee or as self-employed for tax purposes, and the application of the IR35 rules.
 see, Personal service companies: introduction of IR35, Commons Briefing paper CBP914, 13 June 2018. Guidance is published on Gov.uk.
 Budget 2007, HC 342 March 2007 para 5.115
 Changes to the scope of NICs to mirror these rules were made by Order (SI 2007/2070), which took effect from 6 August 2007.
 see, Personal service companies and IR35, Commons Briefing paper CBP5976, 13 June 2018.
Commons Briefing papers SN04301
Author: Antony Seely