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The freelance economy – More problems for contractors and end clients?

While the freelance economy has often been held to have been a major factor behind the success of the UK economy since the 1980s, politicians and HM Revenue & Customs (HMRC) have been attacking many aspects of the model for over 20 years. In particular the awareness of IR35 and the issue of deemed employment, introduced in the public sector in 2017 and in many private and not-for-profit entities in 2021.

However, recent HMRC actions are also undermining the contractor model in another new way, with potentially significant implications for contractors and/or their end clients. Specifically, HMRC have started to attack many contractors (and in effect their lawyers, accountants, and company secretarial service providers) via the ‘Managed Service Legislation’.

Managed Service Companies

The traditional definition of a Managed Serviced Company (MSC) (also known as a composite company), involved a service provider managing various contractors who were shareholders in that entity. The structure was designed to provide the contractors with the tax advantages etc. of being shareholders (e.g., drawing income as dividends), while the contractors avoided, in practice, many of the obligations associated with being owner-managers (e.g., they didn’t have to be a legal director of the business).

Legislation in 2007 in effect undermined the composite company structure and, with the exception of one or two limited cases, there had been little HMRC interest in MSCs over the last 15 years. However, HMRC has now launched a number of enquiries under the MSC’s legislation into the activities of service providers in this area, arguing, in effect, that some of the activities associated with modern accounting services to small contractor businesses may be in breach of this legislation.

The MSC legislation applies where you have the following four characteristics:

  • A business which is mainly involved in the provision of individuals to third party clients
  • Payment arrangements are such that the contractor receives the majority of the third party clients fees which are paid via the service entity, and
  • The individual is receiving a higher income than they would as an employee doing the same work for the service company, and
  • There is an MSC provider who continues to be involved in the contractor’s business.

In this context, the term involvement covers a number of areas. However, the key areas under the legislation are whether the provider has significant influence and control regarding how the services are provided, how payments are received by the contractor and the overall financial health of the contractor entity. Other key factors are whether the provider continues to benefit financially from the arrangement on an ongoing basis and whether the provider (or

an associate) offers warranties or indemnities regarding tax losses and tax risks.

However, the legislation also makes clear that someone providing the services of an accountant or lawyer in the normal course of their business should not be held to be a MSC provider.

So why are HMRC now opening challenges in this area?

While it is often difficult to fully understand HMRC’s logic in starting certain courses of action, it appears that they are now focusing on this area, because some developments in standard accounting or outsourced company secretarial practice might, arguably, be in breach of the conditions given above.

For example, historically advisors believed that a company would only be in breach of the ‘continuing to benefit financially from the ongoing arrangement’ condition in the legislation, if their fees were linked to the contractor’s turnover. However, it now transpires that HMRC believes that pre-arranged, fixed monthly service fees – an arrangement which is quite common in the outsourced accounting arena – are enough for this condition to be satisfied.

Moreover, the initial challenges from HMRC also focus on the use of standardised technology and systems for the provision of services to clients. HMRC appears to believe that the use of such tools, which are typically much more cost effective and secure than traditional paper files, for example, can be a sign that the service provider has ‘significant influence & control’ over the contractor’s business. Again, many accountants and wider business service providers use such tools and actively encourage their clients to utilise them (sometimes by fee reductions, for example).

Additionally, it is worth noting that HMRC are now holding that a provider can be ‘involved’ in the contractor’s business if there are only two or three of the five potential factors at play.


What does this mean for advisors, contractors, and end clients?

In practice, it is quite likely that the HMRC challenge in this area will need to go to court before one has a legitimate feel for the ‘final position’. However, as the MSC legislation specifically allows HMRC to pursue either the contractors or ‘relevant third parties’, which could just potentially include end clients, for the tax and NIC losses, it may be sensible for parties to:

  • Review whether they are potentially caught by the MSC legislation, and
  • Consider whether there is any value in potentially putting a provision in place for any tax or National Insurance contributions (NIC) which might be due, and
  • Ensure they understand the implications from a labour supply perspective if there are any problems in this regard.

Contractors and advisors should also ensure that any initial guidance or recommendations aren’t just presented as a ‘fait accompli’ but is something which is, for example, used as the basis of subsequent analysis and discussions. From a contractor perspective, this could logically be internal discussions, e.g., between shareholders in the business or alternatively subsequent discussions between the contractor and the advisor.

This ‘review, question and challenge’ approach would, in effect, be looking to utilise the comments which were provided by the Government when the original MSC legislation was introduced in 2007, to defend the ongoing arrangements from a commercial and legitimation perspective. In this regard, the Government specifically stated: “There is a distinct difference … between who provides independent, tailored advice to a client, who is then able to consider the advice before accepting or rejecting it, and the person who simply supplies a standard solution … which the client (then automatically) accepts”.

Clearly, any attempts to utilise the Government’s 2007 feedback in discussions with HMRC (or potentially before the tax tribunal), would need to be backed up by meeting minutes, e-mails to the advisors questioning any areas of uncertainty and notes of telephone calls with accountants and company secretarial advisors. Clearly such back-up documents should be prepared on a timely basis.

Final thought

While there is legitimate reason for contractors, advisors, and end clients to be concerned by HMRC’s recent actions under the MSC legislation, the recent National Audit Office (NAO) report into IR35 and its rollout by HMRC provides a ‘glimmer of light’ for taxpayers.

Traditionally, when HMRC have successfully claimed PAYE and NICs from employers / deemed employers (e.g., under the IR35 legislation), they have, in effect, enjoyed a ‘double win’. That is, they have received payment from the end client employer, though taxes and NICs would typically have already been paid by the relevant self-employed individual or owner-manager of a personal service company (via the relevant tax returns). Thankfully, however, the NAO in their recent report have confirmed that this is not correct / valid. Rather, HMRC should be refunding taxes or NICs which the self-employed or PSC owner-managers have paid, where they subsequently have collected PAYE and NICs from an end client as part of an employment tax audit.

Some difficulties remain in this regard. In effect there is still no HMRC system in place which would allow one to effectively recover the taxes which have been paid initially and now need to be refunded. However, at least there is a clear legal principle which the NAO has established. Moreover, one has to assume that the NAO’s comments re IR35 refunds will also be relevant for MSC company settlement situations.

Would you like to know more?

If you would like to find out more about the above, please get in touch with your usual Blick Rothenberg contact or Robert Salter using the details on this page or form below.

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