Why Costelloe’s lost MSC appeal may hold wins for contractors

With the contractor compliance cocktail strong enough at present that you’d be ill-advised to strike a match, there’s two shots of reassurance that can be poured from a company losing its appeal against the MSC legislation, writes Carolyn Walsh, director of CWC Solutions.

In fact, Lady Justice Rose when considering the appeal of Costelloe Business Services helpfully explored the relationship between Chapters 8 and 9 ITEPA, known as the IR35 and MSC rules respectively.

IR35 or MSC, not both

She highlighted that the two legislative frameworks are mutually exclusive, meaning that if an arrangement falls within Chapter 9 (MSC rules), it cannot also fall within Chapter 8 (IR35 rules). And vice versa. It’s nice to know you can’t mix amid an already heady cocktail of contractor compliance. This is the first dram of reassurance from the Costelloe case.

To outline it further, one of the conditions for IR35 to apply at Chapter 8 section 49(1)(c) states: “The circumstances are such that, if the services were provided under a contract directly between the client and the worker, the worker would be regarded for income tax purposes as an employee of the client.” Whereas a condition for an ‘MSC’ at Chapter 9, section 61B(1)(d), is met where a provider ‘promotes or facilitates the use of a company (MSC provider), and that company provides services of an individual (the MSC).’

In the Costelloe case, the company was trying to claim that a group of individuals appealing (five in total  -- out of 350 that Costelloe set up as PSCs in three months, part of a wider pool of 1,000 it had incorporated by 2007), were supplying services via a Personal Service Company. It is here that IR35 is evoked again, despite it being mutually exclusive to the MSC rules. Indeed, the aim of both the IR35 and MSC frameworks is to negate the dividend-led tax advantages of providing the services of an individual to others whereby, if either apply, the legislative effect is to treat fee income as employment income, and deemed payments are retrospectively deemed payable under PAYE.

It is possible that a situation could arise where the individual would not be seen to be an employee of the hirer if his or her company did not exist, but due to the involvement of an MSC provider, could fall within scope of MSC legislation. And as IR35 and MSC legislation are mutually exclusive, then the MSC rules would prevail and are such that, the fee income paid via that company would be deemed to be employment income.

The Costelloe case (cont.)

Appearing for HMRC in the Costelloe case, a Mr Nawbatt QC stated that any workers who are ‘in business on their own account’ and who are concerned that they might accidentally fall within the definition of an MSC, can adapt their working arrangements to make sure that they are not caught by the April 2007 rules. (Exerting control over their company tax affairs; maintaining control over the business bank account and being fully involved in the submission of the company tax returns, are a few ways contractors with such concerns can respond).

However, there could actually be a benefit to both the individual providing services through a company, and agencies or hirers paying those companies, particularly in volume, where a third-party takes on a management and administrative role in the arrangements. Where a company is in business solely as an MSC provider, it follows that MSC legislation applies unless one of the other conditions are not met.

When the MSC rules don't apply

Specifically, see Chapter 9 section 61B (1)(c) because it says, if the way in which those payments are made does not result in the individual 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, then MSC legislation does not apply.

Again, as IR35 and MSC are mutually exclusive, if an individual uses an MSC service provider and pays tax and NI on his or her company fee income under a system that operates the deemed payment method, then neither IR35 nor MSC legislation applies.

But where IR35 applies (from April 2020)...

Now, bring in the fact that the proposed reform of IR35 in the private sector from 2020 will require ‘fee-payers’ to deduct tax and NI on PSCs’ fee income where IR35 applies. This requirement, although complained about by recruiters as burdensome to them, will actually land contractors with administrative and accountancy costs too, paradoxically making operating under an MSC suddenly seem a slightly more attractive solution, at least for short term contracts.

This is because, in general, the MSC does not move with the worker from one assignment to the next, rather the scheme provider will place another worker in the vacated MSC. In other words, the MSC is not associated with the worker but with the provider, which means less responsibility falling on the individual, other than ensuring that tax and NI has been deducted and paid over to HMRC appropriately.

For genuinely self-employed individuals supplying services to hirers through a company, the focus remains on ensuring contracts fall outside IR35 and, in the words of HMRC’s own QC, the onus is on those individuals to ‘get out’ of MSC schemes pronto.

That’s the second sort of reassurance that can be extracted from Costelloe’s loss. And it’s a potentially surprising one. So, where IR35 applies from April 2020 in the eyes of your engager, and where tax and NI deductions are set high, contractors wishing to remain independent, need to secure higher rates and pay less for running their company – or, if not, the MSC may be a tipple seriously worthy reading the label of, ahead of potentially sampling it.