Landmark MSC case – but are we any more the wiser?
Nine years after the Managed Service Company (MSC) legislation was passed we now have the first ruling following an appeal before the First Tier Tax Tribunal in the case of Christianuyi Ltd and others v HMRC. Five companies who were clients of Costelloe Business Service Ltd (CBS), the MSC provider, were disputing that they were actually MSCs in the hope of escaping a total tax and NIC bill of just over £159K covering the years 2007/08 – 2009/10.
All the appellant companies were single person PSCs providing professional services in the health and social care sectors, as were the majority of CBS’s clients. CBS’s clientele included doctors, health care workers and social workers, many of whom had previously worked directly for the NHS.
Pre-July 2007
Prior to July 2007 CBS, in alliance with its associated company, referred to as ‘i4IoM’, offered its clients a ‘composite company’ product which was run from the Isle of Man.
Composite company models were the cause of HMRC introducing the MSC legislation. They would involve a number of contractors, none of whom usually knew one another, ‘grouped’ together in one company. The company would be controlled by an MSCP who would also own shares in the composite, although the majority of shares would be held by the individual clients. The MSCP would run the composite companies with the individual contractors having no involvement in the day-to-day running of the companies.
With the advent of the MSC legislation in April 2007, CBS developed a new product, the ‘Gold Business Service’ that would enable existing composite company clients to move into. Although a letter was sent out to all composite clients offering the choice of operating through their own PSC or via an umbrella company, in line with CBS’s expectations, almost all of the clients moved over to the new PSC model.
Gold Business Service (GBS)
The GBS was a standardised product which allowed each contractor to own their own PSC.
CBS never met its individual clients and any contact was either by letter, e-mail or by telephone.
There was no evidence that CBS discussed with their clients whether the GBS was, in fact, suitable for them and no bespoke advice was given as to whether the service was appropriate to the clients’ circumstances.
CBS bought large quantities of off-the-shelf companies in anticipation of hundreds of clients moving across from the composite model to the GBS. In total approx. 1,400 new companies were incorporated by CBS, of which around 1,000 were used to provide PSCs to clients during the period 6th April 2007 – 31st March 2010. Virtually all clients had as their company secretary a CBS group company, Costelloe Secretaries Ltd.
CredEcard accounts
All clients were offered a CredEcard account and there was no evidence of any discussion with individual clients about different banking options. As at August 2010, CBS clients held 1,000 accounts, with only 11 clients holding their own bank accounts.
In accordance with a client mandate, CBS were able to withdraw funds from a clients’ CredEcard account but clients only discovered how much had been debited from their accounts when they received their payslips, ie after the debits had been made.
There was no suggestion however that CBS abused this authority by withdrawing amounts which were not owed to it.
CBS fee’s
The letter of engagement sent to clients in March stated that CBS would charge 5% plus VAT (4.75% post tax) per invoice transaction. As this method of charging would have triggered the MSC legislation, in July 2007 CBS moved to a fixed fee of £35 + VAT each time work was undertaken. The fee structure changed yet again in December of that year, where an annual fee of £1,350 + VAT was introduced. Despite this, CBS continued to invoice clients on an ad hoc basis.
Client extraction of profits
The CBS registration form invited clients to indicate whether they wished to use what was called the ‘minimum wage’ model. In practice, clients extracted money from their PSCs by way of a combination of payments of remuneration (equal to the minimum wage) and the balance transferred from their CredEcard accounts to their own private bank accounts.
Whilst the registration form allowed clients to select another ‘specified amount’, there was no guidance as to what that should be and CBS did not advise clients on which type of remuneration structure would best suit their needs.
As at August 2009, 99% of clients were on the minimum wage model.
None of the five appellants provided evidence that any of them specified the amount of dividends they were to be paid from their CredEcard accounts or indeed that such payments were to be characterised as dividends.
No evidence of genuine resolutions approving the payment of dividends existed and CBS would only produce dividend tax vouchers automatically at the end of each tax year.
The unaudited accounts of the appellant companies recorded no interim dividends but simply a final dividend.
Individuals simply seemed to withdraw money from their PSC CredEcard accounts as they pleased.
Accounting for tax and NIC
CBS deducted tax and NIC from its clients’ CredEcard accounts to cover PAYE, NIC, corporation tax and VAT. These deductions were made in accordance with the agreement contained in the registration form.
Substantial amounts were deducted from clients’ accounts before it was due and in some cases long before it was due. For example, CBS would hold corporation tax for up to 19 months after they first started collecting funds from their client companies.
The taxes deducted by CBS were held in its own interest bearing accounts. At one stage over £4 million was transferred into their account over a 22 month period, earning interest of £127K. None of CBS’s clients were aware that the monies ring fenced for paying their taxes was also accruing interest for the benefit of CBS alone.
With effect from 1st April 2010 CBS ceased trading and clients were informed that they should now operate through CBS group companies and a company called i4 Services Ltd started providing a PSC product.
MSC legislation – What is an MSC?
An MSC is either a company or a partnership whose:
- Business consists wholly or mainly of providing the services of an individual to others;
- More than half of the MSC’s income is paid on to the workers in some form;
- PAYE and NIC are avoided on remuneration paid to the worker; AND
- An MSCP (someone who carries on the business of promoting or facilitating the use of companies to provide the services of individuals) is involved with the company.
MSCP involved with their client
Being labelled an MSCP does not automatically mean that their client companies are MSCs and that the legislation applies. The key test is whether or not the MSCP is involved with their client. Involved is defined by reference to just any one of five activities:
- Benefiting financially on an ongoing basis from the provision of the services of the individual. Where an MSCP’s fees are linked directly to the worker’s activity, e.g a percentage of the clients’ sales invoice then this would satisfy this criterion.
- Influencing or controlling the provision of the services of the worker. This would be present where an MSCP provides a mandatory contract for services or dictates/determines the terms under which the worker provides the services or is to be remunerated.
- Influencing or controlling the way in which payments to the worker are made. It should be the client who determines how they distribute their profits. Where profits are distributed in accordance with a standardised product and which, in reality, the client has little or no control or influence, then this category would be satisfied.
- Influencing or controlling the client company’s finances or any of its activities. Where an MSCP controls its client company’s bank account and organises the day-to-day administration of its finances, then this category would be fulfilled.
- Giving or promoting an undertaking to make good any tax loss, e.g tax enquiry insurance would be fine but not insurance that covers IR35 taxes as well.
Application of the MSC legislation
Where a company is caught by the legislation then all of the company’s income is treated as earnings subject to PAYE and NIC.
The judgement
The Tribunal found that the CBS were indeed an MSCP that was very much involved with its client companies for the following reasons:
Benefiting financially on an ongoing basis
The original fixed percentage fee was, as CBS recognised, an activity that would be caught by this category. The fixed fee per transaction was only charged when a payment was received by the PSC. Moreover, the fee related to the number of payments received by the client from the agency rather than the number of times the payroll had to be run or a payslip produced. Thus, if the client received two payments in one week from the agency, CBS ran one payroll and produced one payslip but charged two fees. The fees therefore related to the number of payments received and this was enough to fall foul of this criterion.
Additionally, the fact that CBS earned interest on monies held on account to pay client taxes also fell within this category.
Influencing or controlling the way in which payments to the individual are made
The tribunal considered the meaning of the expressions ‘influences or controls’ as there is no authority on the meaning of the phrase. In its view ‘control’ means the exercise of the power or the ability to command or direct. Furthermore, the Tribunal felt that control can be shared and need not be exclusive.
‘Influence’ involves a person acting in such a way that it has an effect on another person or thing. An MSCP therefore ‘influences’ the way in which payments to the individual are made if its actions or omissions have an effect on the way in which payments to the individuals are made. It is not necessary that, in order to influence behaviour, the person exercising influence should have the power to ensure or direct that the other person acts in accordance with their wishes.
It was concluded by the Tribunal that it was CBS that determined that surplus funds were paid by way of dividend and in so doing fell foul of this criterion.
Influencing or controlling the company’s finances or other activities
Nearly all of CBS’s clients opened CredEcard accounts for the purposes of the GBS and used them to pay CBS fees. In persuading a client to use a particular bank or payment account amounted to influencing the company’s finances or any of its activities.
CBS also controlled its client monies deducted in respect of taxes pending the payment of that money to HMRC because the monies sat in a bank account earning interest without the knowledge of its clients.
It is a pity that this should be the first case to be ruled upon in respect of the MSC legislation as CBS made many serious mistakes in the provision of its services to its clients which one could not fully describe as streamlined. Litigation however was being funded to a “substantial” degreed by CBS and/or its directors on the basis that they faced the ultimate financial liability for the tax and NIC under the debt transfer provisions and indeed HMRC are now seeking to do just that.
What this case does demonstrate is how widely the MSC legislation can be interpreted but then again it was always designed that way. We do now have an insight as to how the courts will view an MSCP’s activities and there will, no doubt, be a number of providers sweating, particularly given that there are a number of other MSC appeals which are pending before the First Tier Tribunal. Of course, tribunal cases are not legally binding and we may see, in time, an appeal moving up through the courts at which point a legal precedence will be set.
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