IR35 and Managed Service Company Legislation

As a contractor you need to ensure you are fully are aware of the rules governing the way in which you run your payroll.

One of the major benefits of using MyPay is that you have 100% peace of mind that you are compliant with both IR35 and MSC legislation .

To find out more about both of these legislation please read below

IR35

What is IR35?

The term “IR35” originally came about in a budget press release which was issued by the Inland Revenue in September 1999 and came into affect from the 6th April 2000.  This legislation was designed simply to close a loophole being used by many contractors to avoid paying large amounts of tax and National Insurance Contributions (NIC’s).

This was being achieved by individuals who would use intermediaries such as Personnel Service Companies (PSC’s), Composite Companies or Partnerships to reduce their liabilities.  In many cases you would have someone finishing the work on the Friday as an employee only to start again on the Monday through an intermediary to greatly increase the tax efficiency of their pay.

IR35 stated that if the relationship would have been that of employer and employee, however the only difference is that they our now using an intermediary, then that person needed PAYE tax on all their earnings - just the same as an employee.

Before the legislation was introduced towards the end of the 1990’s the Inland Revenue and Treasury estimated that literally billions of pounds of tax and NI revenue was being lost by the practice of individuals working through intermediaries.

So does IR35 affect me?

Much like any legislation IR35 is open to interpretation and many people have found themselves to be in breach of the regulation, many of whom never thought it would have affected them. There has been a whole series of court cases where people have been charged back dated tax, interest and fined anything up to 7 years after the event ever since IR35 was introduced.  It is considered a general rule that if you run through an intermediary you potentially run the risk of IR35. 

The HMRC do give a general guidance as to which engagements our likely to qualify for IR35 and this is called IR56.

IR56 guide to employment status

In tax and social security legislation they do not have any definition of employment or self employed.  There is only guidance from the HMRC and previous court cases to help you decide.

With IR35, however, this highlighted the need for such information as the whole basis of the legislation is based around employed versus self employed so the HMRC published IR56 to run alongside IR35 and help the individual to determine their status.

The guidance sets out a list of questions about the individuals work in practice to determine their employment status and the relevance of IR35 to them.

IR56 – employed or self-employed

Employed

If you answer yes to any of the following you will probably be viewed as an employee by the HMRC and be affected by IR35 - This is normally referred to as being inside of IR35.

• Do you have to fulfil the contract personally (as opposed to sub-contracting or using a colleague)?
• Do you have a line manager or someone you report to who tells you what to do and how and when to do it?
• Do you work fixed hours both in term of when and how long you work for?
• Can you be sent to work on different tasks?
• Can you qualify for overtime or bonus payments?

Self-Employed

If you can answer yes to all of the following you would probably be viewed by the HMRC as being self-employed and therefore not affected by IR35 - normally termed as being outside of IR35.

• Can you send in a substitute or hire someone to do the job at your own expense?
• Do you risk your own money?
• Do you provide all the main equipment required to complete the job?
• Will your job for the clients be completed for a fixed agreed price regardless of the time taken to complete the project?
• Can you do what they want in your own way, when and where you want to in order to fulfil the contract?
• Do you regularly work for a number of different clients?
• Do you have to fix mistakes in your own time and at your own expense?

Please click here for the specific wording and link to the HMRC website detailing IR56.

What are my options if I fall inside IR35?

If like the vast majority of contractors you are affected by IR35 you need to ensure that you are paying PAYE tax and National Insurance Contributions (NIC’s) in order to be compliant.

The most popular option for contractors affected by this legislation is umbrella companies.  These have grown in popularity significantly ever since their introduction in 2000 and with the MSC legislation in the 2007 budget more contractors and freelance professionals are using these companies than ever before.

The reason for this is that because they pay Income Tax and Class 1 NIC’s on your earnings.  You are 100% compliant with both legislations.

Managed Service Company (MSC) Legislation

What is MSC legislation?

The MSC legislation first came about in the pre-budget report in 2006 and was later announced in the budget 2007.  The legislation was designed to run alongside IR35 and stated that any contractor who was running through a Managed Service Company would now have to pay tax and National Insurance contributions on a PAYE basis as an employed person.

What is a Managed Service Company?

A Managed Service Company is classed as any company that is involved within the financial affairs of the company or individual. The term involved is yet to be fully defined, so a lot of questions are being asked over any company that still offers a dividend payment to their staff to ensure they do not fall under the MSC legislation.

Why was the MSC Legislation Introduced?

The MSC legislation was introduced as the HMRC deemed that a proportion of contractors were not paying their fair share in both tax and National Insurance Contributions.  They also stated that certain methods of payroll companies were making corporation tax too easy and that the IR35 legislation in practice had been very difficult and time consuming to enforce.  So this legislation was designed to make the whole process of contractor pay easier for the HMRC to police.

When does the MSC legislation come into effect?

The legislation came into affect for all contractors, service providers and agencies throughout the tax year 07/08.

Contractors – April 2007

Service Providers – August 2007

Agencies – January 2008

This means that if the incorrect tax is now being paid the debt can be transferred to any of the 3 parties due to the new transfer of debt provision.

Transfer of Debt Provision

The transfer of debt provision is the ability the HMRC can use to claim the debt from any of the involved parties.  The HMRC will always try and claim any unpaid tax from the individual, however if they are unable to do so they have the ability to claim it from the service company.  Also, for the first time, the debt could be transferred to the agency if the HMRC see it as applicable.

Affects of MSC

MSC legislation and Contractors

The MSC legislation has made it more important than ever for contractors to ensure they use the correct company to run their payroll.  The reason for this is that if a company was to pay a contractor a dividend payment and then later be discovered to be a MSC then the contractor would potentially have to pay back-dated tax, interest and fines. This is before you even take the risk of IR35 into account.  For this reason more and more contractors have moved from dividend solutions to umbrella solutions ever since the legislation was announced.

MSC legislation and Agencies

Since this legislation was introduced more and more agencies have decided they do not want to run the risk of potentially having any debt transferred to them.  So in order to alleviate this risk they will only use and refer to companies that pay employed tax and NIC. This way they know both they and their contractors can have total peace of mind.

MSC and Service Providers

When this legislation was first introduced a large amount of service providers had to dramatically alter the way in which they operated.  These companies were mainly known as composite or managed limited companies and provided a dividend payment for contractors.

A lot of these companies changed to offer an umbrella solution as it remained 100% compliant.  Other companies were unable to change and called it a day and some altered to offer an accountancy service for contractors who set up their own company.  These companies were set up in such a way that the contractor became the director of their own limited company , employed their services and told them how you wanted your payroll run. This means, unlike on an Umbrella Company, the HMRC hold you, the contractor, responsible. So if the payroll is completed incorrectly the potential risk falls squarely on the contractor.

MSC legislation and MyPay

The great news about using MyPay is that none of the three parties (contractor, agency and MyPay) will ever be at risk of the transfer of debt legislation.  As we provide a tax efficient solution, whilst still ensuring compliance by paying employed tax and National Insurance Contributions, this legislation will never affect ourselves, our contractors and any agencies that use us.