In an effort to circumvent IR35 a number of providers set up composite schemes which the Government later termed, “Managed Service Companies“.
In such an arrangement, typically up to 20 contractors become non director shareholders with the company being managed by the “scheme provider”. The individual contractors were paid a low salary together with generous expenses with the balance paid as dividends. This structure of payments was extremely tax efficient as it avoided significant sums of national insurance and tax that would have been suffered by a contractor paid wholly via PAYE.
However, for a contractor to legitimately be paid in the form of dividends they must be outside of the IR35 legislation and it was the view of HMRC that this was not the case in a vast number of instances.
They therefore legislated and introduced the “Managed Service Company” legislation in April 2007.
This legislation states that unless a contractor can show that…
- They are in business on their own account.
- Their business in not controlled by a “provider”
…all of the income from their company must be paid to them as salary and suffer full PAYE and national insurance.
It should be noted that for this legislation to apply their must be a company that the contractor is a shareholder of and receives income in the form of dividends. This legislation does not apply to contractors using PAYE umbrella companies as these deduct PAYE and NI and do not pay their contractors in the form of dividends.
The following guidance notes from HMRC are very helpful in providing additional information about this legislation – Managed Service Company legislation: unpaid PAYE and Class 1 NI contributions avoidance schemes (Spotlight 32)