IR35 and MCS in breif
For many contractors, working through a limited company and being able to pay themselves in dividends has been a sensible and tax efficient way of running a business. Indeed, over the years, the government has even introduced incentives for self-employed workers to work in his way. However, by the year 2000, the government became concerned that too many workers, who were not genuinely self-employed, were setting up limited companies, and that they were being encouraged to do so by service company providers and employment businesses for whom such arrangements were also profitable. This resulted in the introduction of the IR35 rules in that year's Budget.
The effect of IR35 is to prevent limited company workers from paying themselves in dividends unless they are genuinely in business on their own account. This is achieved by looking at the contractual and working relationship between the worker and the end user client and asking if that relationship is a self-employed or employed one. Where the relationship is seen as an employer/employee one, PAYE must be applied to the fees after expenses.
The government now believes that too many workers, or their service company providers, have not applied the IR35 rules as rigorously as they should have done resulting in a loss of PAYE and National Insurance contributions to the Treasury.
To counter the loss of revenue duties, the MSC (Managed Service Company) rules were introduced on 6 April 2007. These new rules impose a PAYE liability on a personal service company in circunstances where a service provider has facilitated, encouraged or otherwise been involved in the provision of a managed service company. The rules are backed up by provisions which allow an underpayment of PAYE to be collected from the worker, or the MSC provider, or from an employment business or end user client that has been actively involved in the promotion of the service company.
Since the new rules were introduced, some contractors have decided to look for a permanent position and others have decided to join an Umbrella organisation. However, where a contractor is running his or her own personal service company with the assistance only of a normal accountancy service, the MSC rules do not apply and the profits of those companies may stil be distributed in dividends. In these circumstances the IR35 rules must still be applied.
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