HMRC success in long awaited MSC case

Just over 9 years after the infamous Managed Service Companies rules came into force, the very first judgment on the legislation has been released by the First-tier Tax Tribunal.

The case centres largely around a company called Costelloe Business Services Ltd and its associated company i4 Group Ltd (which we will refer to as “CBS” for simplicity). However because of the way the MSC legislation works the appeals were actually brought by 5 companies which HMRC alleged to be ‘Managed Service Companies’ because CBS was involved with them.

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Introduced in April 2007, as a reaction to the perceived mass marketing of service companies (in particular so-called ‘composite companies’), the MSC legislation is both notorious and complex. There are wide-ranging debt transfer rules and many uncertainties in its application.

Although there are a few additional intricacies, the MSC legislation basically works by looking firstly at whether there is an ‘MSC Provider’, and, if there is, asking whether that MSC Provider is involved with a company. If it is, the legislation applies.

An MSC Provider is defined as a person who “…carries on a business of promoting or facilitating the use of companies to provide the services of individuals”.  The basic idea is that the rules should apply to those who are setting up and essentially running service companies on behalf of workers. However there is an exemption for those who are merely providing legal and accounting services in a professional capacity.

“Involvement” is defined in five different ways, only one of which needs to apply. More detail on this below.

If there is both an “MSC Provider” and “involvement” then (providing various other less relevant technical conditions are met) all payments to the worker, including any dividends, must be taxed as employment income. Those workers already being taxed as employees are generally exempt, hence the legislation does not usually apply to umbrella companies or service companies where all the payments to the worker are taxed under PAYE.

In this case HMRC alleged that CBS was an MSC Provider, and all the companies it provided a service to were therefore MSCs, as CBS was involved with them.

Perhaps surprisingly, CBS and the appellants conceded part way through the dispute that CBSi was indeed an MSC Provider. CBS did not claim the exemption available for those merely providing legal and accounting services. The argument was instead that CBS was not “involved” with the companies, and therefore the MSC legislation did not apply on that basis.

This means that the judgment whilst noteworthy for many other reasons is of limited value for those looking for any judicial clarification of the boundaries of the accountancy exemption. That would have been very useful, as both the legislation and HMRC’s guidance leave a lot of questions unanswered.

See also VAT surcharge appeal

Was CBS “involved” with its clients?

As mentioned above, “involvement” in the MSC legislation is defined in five specific ways.  Only one need apply.

Having conceded that CBS was an MSC Provider, the appellants had the burden of proving facts to show that none of these forms of involvement applied.  Specifically, it was alleged by HMRC that CBS was involved with its clients in three of the five potential ways:

  • CBS benefited financially whenever the worker actually provided their services
  • CBS influenced or controlled how the worker received their payment
  • CBS influenced or controlled the worker’s company finances or other activities

We have paraphrased these for simplicity.  The other two forms of involvement are where the MSC Provider influences or controls the worker’s services, or where it underwrites tax losses.  These were not argued in this case.

The Tribunal decided that all three forms of involvement were indeed met, and as a result (as only one needed to be met) CBS was involved with its clients and they were therefore all MSCs.

The judgment is lengthy and detailed.  However we have set out below some stand-out features of the relationship between CBS and its clients in order to understand how the Tribunal approached the tests.

CBS provided a standardised product to clients.  It had no substantial discussions with its clients about the services it would provide to their companies, and no real discussions about the individual’s salary levels – after some initial form filling there was generally minimum contact.

A particular feature of the product was a pseudo-bank account known as CredEcard, from which CBS was mandated to deduct its fees and money on account of tax liabilities, and which CBS duly paid over to HMRC on its client’s behalf.  However despite informing clients that the monies would be held in a client account, CBS in fact held the money in its own interest-bearing accounts and retained the interest itself.  Earned interest of £126,936.18 was identified in relation to a 22 month period by the Tribunal, and in cross-examination a director of CBS admitted that he had previously lied to HMRC (as well as misleading CBS’s clients) about this point.

Unfortunately this additional income stream for CBS backfired somewhat – the Tribunal decided that because CBS had drawn this money from its clients’ bank accounts each time the worker was paid and then held on to the interest, this constituted a financial benefit derived from the worker providing services, and therefore a form of “involvement”.

There was also a detailed focus by the Tribunal on the dividends paid to the workers by the client companies, as 99% of CBS’s clients had adopted a typical ‘minimum salary plus dividends’ arrangement.  Despite CBS providing HMRC with minutes of meetings whereby dividends had been declared by the directors of each company, CBS had to admit that the meetings had never in fact taken place and the documents were false.  The Tribunal accepted that CBS would not be influencing or controlling how the worker received their payment if the clients had signed instructions authorising CBS to make dividend payments – but this was simply not the case.  None of the appellants really had any idea about the fact or the level of their dividends (some of them didn’t even appear to understand what dividends were).

The Tribunal also closely analysed CBS’s fee structure.  Despite the fact that (at least latterly) CBS appeared superficially to charge its clients fixed accountancy fees linked to the services CBS was providing, the Tribunal looked through this and concluded that the fees were really directly linked to the worker providing their services; no fees were charged when the worker did not work for example.

In summary, the Tribunal held that there was a great deal of control and influence over the client companies.  CBS was involved and the companies’ appeals failed.

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This is a momentous case in that it is the first MSC judgment, and a long awaited one at that.  Most recent legislation with an anti-avoidance purpose is drafted widely and purposively, so it is always interesting to see how certain key phrases are interpreted when cases reach the Tribunal.

Beyond that however there is little that can be taken from this judgment either way.  It will give neither concern nor comfort to most interested parties, and the approach taken by the Tribunal accords precisely with the advice we have always given to clients – i.e. once it is conceded that there is an MSC Provider it is virtually impossible to avoid ‘involvement’ in one of its five forms.

The Tribunal reinforced this advice by describing the MSC Provider condition as the ‘gateway’ to application of the MSC legislation, and it really is the main battleground in any dispute.

To give an example of just how wide the forms of involvement can be, the Tribunal found in this case that most of CBS’ clients had used a recommended bank account (the CredEcard arrangements) but that this did not of itself constitute any involvement.  However because CBS had incentivised its clients to use CredEcard by waiving a 5% surcharge it would otherwise levy on its fees, this constituted an influence over the companies’ finances and this meant that CBS was involved with the companies.  Indeed the Tribunal observed that the five forms of involvement should be “construed widely” and that the legislation used “expansive language”.

This again underlines just how important it is that accountancy service providers specialising in the service company sector do not stray outside the exemption for providing professional legal and accountancy services.

In CBS’s particular case there were some ‘aggravating factors’ which could not have hurt HMRC’s case: CBS’s witness were described as evasive and unhelpful, and they had misled HMRC during the investigations.  There were also issues with late disclosure of documents by CBS – including the incriminating bank account statements showing the sums of interest secretly earned by CBS on its clients’ tax monies.  A lack of attention to paperwork also let CBS down in several respects, so that where they claimed to be acting on instructions from their clients they could not support this with documentation, thus exposing them to the allegations of exercising their own control and influence over the companies.

However, the bottom line is that the outcome of this case was probably sealed once the appellants had conceded that CBS was an MSC Provider.

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What next for the MSC legislation?

Although this is the first case on the MSC rules, it is likely that several others will now follow.  The Tribunal observed as much in its judgment, and also referred to separate debt transfer proceedings being taken by HMRC against CBS.

This will be an interesting aspect to this case.  The liability over three years in relation to the five appellants totalled about £160,000.  Extrapolating this figure across the 1,000 or so service companies apparently advised by CBS gives us a liability in excess of £3 million, and of course this is just for a three year period out of the six years that HMRC can typically prosecute.  Clearly the duty being pursued by HMRC will be substantial, and the debt can be transferred to the directors of CBS personally.  For this reason alone a further appeal seems likely.

Also notable from the judgment is the extent to which the agencies had encouraged (or even insisted) that the workers used a service company – and had referred them to CBS.  The targets of the MSC debt transfer rules include anybody who has ‘encouraged’ or has been ‘actively involved’ in a worker going into an MSC, so any agency that has referred workers to CBS will be reading this judgment carefully and perhaps nervously.

This aspect emphasises just how important it is for an agency to ensure its Approved Supplier List includes only suppliers who have been carefully and properly vetted from an MSC perspective.

For advice on the application of the MSC rules, please contact the Chartergates team.

The full judgment can be found here.

Published: 05.06.16 - Posted In: Latest News