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What are the managed service company rules?

Author: David Kirk

Published: 01 Nov 2024

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In the first of two articles exploring the managed service company rules, David Kirk looks at the definition of an MSC and explains the consequences of falling within the scope of the rules.

Author’s note: In these articles I am attempting to explain what I believe is HMRC’s position. Many of the views given here are not my own: indeed I am in the process of challenging a good many of them. It will, however, be some time before the tax tribunal and the courts come up with the final word on this.

HMRC was approached in advance of publication and gave the following comment: “We appreciate there’s a real person behind every bill and we recognise dealing with large tax bills comes with significant pressure. Our message to anyone worried about a tax liability is to contact us as soon as possible to talk about options. The managed service company rules exist to help ensure people who work like employees pay tax like employees.”


The managed service company (MSC) rules have hit the headlines over the past few years following challenges from HMRC that the rules apply to the clients of two firms. If these cases progress through the courts, we may get some more clarity about when the rules apply. In the meantime, firms providing services in this space will rightly be nervous about overstepping a boundary given the potential consequences – not only for their clients, but also the firm. 

The MSC rules

The MSC legislation is found in Ch 9, Pt 2, Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). It was introduced in 2007 to overcome the difficulties that HMRC had in applying the IR35 rules to MSC workers. 

At the time of its introduction, its primary purpose was to tackle the promotion of ‘composite company schemes’. This was where several (usually 10 to 20) workers were made shareholders of a company with each holding a different class of share so that different amounts of dividend could be paid. However, the legislation was drawn widely in anticipation of the market adapting to its introduction, eg, shifting towards the use of personal service companies (PSCs). A PSC is a company whose business consists of selling the services of its worker shareholder.

Where a worker providing their services through an MSC receives payment for those services, the MSC is treated as making a payment of employment income to the worker. There is no status test; payments are automatically treated as employment income regardless of whether the contract would be classified as one of employment. 

Where a worker providing their services through an MSC receives payment for those services, the MSC is treated as making a payment of employment income to the worker

The transfer of debt rules were also amended in 2007. Specific legislation allows PAYE and national insurance contributions (NIC) debts to be transferred from the MSC to appropriate third parties.

What is an MSC?

The legislation (s61B(1), ITEPA 2003) says that a company is an MSC if it meets all of the following four tests:

  1. its business consists wholly or mainly of providing (directly or indirectly) the services of an individual to other persons;
  2. payments are made (directly or indirectly) to the individual (or associates of the individual) of an amount equal to the greater part or all of the consideration for the provision of the services;
  3. the way in which those payments are made would result in the individual (or associates) receiving payments of an amount (net of tax and national insurance) exceeding that which would be received (net of tax and national insurance) if every payment in respect of the services were employment income of the individual; and
  4. a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals (“an MSC provider”) is involved with the company.

Provision of services

All that is necessary for the first condition to be fulfilled is that the company has individuals who provide services. If the company sells goods, it is not an MSC.

Example 1: IT consultant

Roger is a specialist IT consultant, who trades through his company, Software Intel Limited. He gets his business through IT consultancies who fix up assignments for him to work for large international businesses, making the IT systems of businesses that they have taken over compatible with those of the parent group. These assignments usually last a year (although they are often renewed); the contracts between the consultancies and Software Intel Ltd are drawn up by the consultancies expecting that he will personally be doing the work. He reports to someone in the large international business.

Software Intel Ltd fulfils this condition. The business of the company is to provide Roger’s services to these large international businesses.

Example 2: conservatory installation

Roger supplies and installs conservatories for residential customers through his company, Roger’s Conservatories Limited. Typically, he will buy the materials for about £3,000 and spend about a week installing them, doing most of the work himself, and charge his customers £8,000.

Roger’s Conservatories Ltd is not an MSC. Although Roger does most of the work, its business is not to supply his services but to supply conservatories. It might be different if the customers bought the conservatories directly and he merely installed them.

Example 3: lettings agent

Tina is a commercial property letting agent. Her company, Tina’s Estates Limited, acts for both landlords (finding tenants for them) and tenants (finding offices for them to rent), helping her clients to negotiate terms, and she sometimes helps them with rent reviews as well. She generally charges a success fee of 10% of the first year’s rent, so does not get paid when she fails to fix up a deal. Her company’s terms and conditions do not say anything about who will be doing the work, although in practice she does it all. At any one time she will probably have about six pieces of work in progress.

Tina’s Estates Ltd fulfils this condition. Although the contracts do not require this, it is Tina who actually does the work providing the services to the company’s clients. The purpose of Tina’s Estates Ltd is to provide Tina’s services to end-clients. 

It is important to note that this is not a test of employment status and therefore could apply in circumstances outside the off-payroll working legislation. Therefore, Example 3 may appear surprising, but I have received correspondence from HMRC that argues that this type of service falls within the scope of s61B(1)(a). 

Amount that the company is paying out

The second condition is that the company must pay out to the people who do the work the greater part (understood to mean more than 50%) of the money that it earns from their work. This can include payments to associates (eg, relatives) or indirect payments (eg, to an individual’s pension fund). This is considered on a year-by-year basis, using the tax year (6 April to 5 April). If the company pays less than this, it is not an MSC.

Tax saving

The third condition is that the form of each payment from the company results in the recipient getting more than they would if the pay as you earn (PAYE) system were operated on all payments made. If all the payments have PAYE and national insurance contributions (NIC) deducted, the company is not an MSC.

An MSC provider is involved with the company

The fourth and final condition is that the company has an “MSC provider” that is “involved with the company”. 

An MSC provider is a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals. There is an exclusion for providing legal or accountancy services in a professional capacity (s61B(3), ITEPA 2003) which means that the majority of services offered by accountants in practice will not be caught by the MSC legislation. However, members do need to be aware of the legislation and in my second article I will look in detail at the circumstances in which the legislation may apply to treat an accounting firm as an MSC provider.

An MSC provider is a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals

Deemed employment payment

Where the services of a worker are provided by an MSC, and a payment or benefit in respect of those services that has not already been subject to PAYE and class 1 NIC by the MSC is received by the worker from any person, the MSC is to be treated as paying to the worker earnings from employment, known as a ‘deemed employment payment’ (s61D, ITEPA 2003). 

There are three steps to calculating the deemed employment payment (s61E, ITEPA 2003):

  • Step 1: find the amount of the payment or benefit referred to in the preceding paragraph. 
  • Step 2: deduct qualifying expenses incurred by the worker from the amount at step 1. 
  • Step 3: assume that the step 2 amount is gross of employer’s NIC and deduct from the step 2 amount what would be the amount of those contributions. 

Since the MSC legislation was first introduced, the off-payroll working (OPW) provisions in Ch10, Pt 2, ITEPA 2003 can apply to public sector engagements since 2017, and to private sector medium and large clients since 2021. If both the OPW and MSC rules apply, the OPW rules take precedence and the MSC rules will not apply (s61D(4A), ITEPA 2003). 

By contrast, where a service company would be caught by Ch8, Pt2, ITEPA 2023 (Workers’ services provided through intermediaries to small clients) (IR35), but also falls within the definition of an MSC, then the IR35 rules in Ch8, Pt 2, ITEPA 2003 will not apply as the MSC legislation must be applied instead (s48(2)(aa), ITEPA 2003).

If the company is treated as making a deemed employment payment for a tax year, and it has made a distribution in that tax year or a subsequent tax year, the legislation allows for a claim for relief to be made to HMRC to avoid double taxation (s61H, ITEPA 2003). Where a claim is made, the amount of the deemed employment payment is set against, and so reduces the amount of the distribution for tax purposes. The claim must be made within five years after 31 January following the tax year in which the distribution is made. 

Transfer of a PAYE debt

The legislation sets out three broad categories of persons to whom an MSC’s PAYE and NIC debt can be transferred (s688A, ITEPA 2003). These are:

  • the director, or other office holder or associate of the MSC;
  • the MSC provider or the director, or office holder or associate of the MSC provider; and
  • any other person who directly or indirectly has encouraged or been actively involved in the provision by the MSC of the services of the individual, or a director, or other office holder or associate of such a person.

There is a carve out for the provision of legal or accountancy advice in a professional capacity, but this only applies where the person has not been classified as an MSC provider.

The circumstances in which an accountant could be considered to be an MSC provider are covered in a more detailed separate article.

David Kirk, Director, David Kirk & Co Ltd.

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