Managed service companies: thousands of contractors face higher tax bills

Accountants ‒ and the contractors that use them ‒ accused of breaking managed service company legislation, with huge tax bills now being issued.

One of the many attractions of being self-employed is the potentially lower rates of tax you have to pay.

Sure, you don’t get holiday or sick pay, but you likely do get to take home a larger chunk of the money you bring in than your employed peers.

However, it has now emerged that the taxman has set its sights on thousands of self-employed people who work as contractors, with warnings that they could be chased for “tens of millions of pounds”.

You need to pay

Last week it emerged that HM Revenue & Customs (HMRC) had sent tax bills of up to £50,000 to around 1,000 contractors who used the accountancy firm Churchill Knight & Associates.

It all comes down to legislation covering managed service companies (MSCs).

The taxman wanted to clamp down on what it saw as cases where contractors were not really responsible for their own businesses ‒ handing this off to a third party like an accountant ‒ but were still enjoying the tax benefits of being an incorporated body.

HMRC has accused Churchill Knight & Associates of essentially being an MSC, and so by extension, its customers are users of an MSC and so can be charged PAYE and National Insurance on their income.

And that means far higher tax bills across the board for those contractors using the firm for what they believed were simply accounting purposes.

Warning signs of apparently being an MSC include ‘benefitting financially' from the provision of services by those contractors, and ‘influencing or controlling’ the finances and activities of contractors.

In this specific case, HMRC cited the fact that contractor businesses are required to use an online portal developed by Churchill Knight & Associates.

Is this an isolated case?

First of all, it’s worth highlighting that Churchill Knight & Associates has strenuously denied the taxman’s claims, warning that it has “entirely misinterpreted” the legislation and promising to fight back.

This includes setting up an online portal to guide impacted contractors through the appeals process against those higher tax bills.

But it’s also important to recognise that this isn’t going to be an isolated case, but rather the first big example that’s come to light.

The reality is that plenty of other accountants that operate similar business models are going to be subject to similar claims from the taxman, and their customers are going to be whacked with massive tax bills.

Indeed, there have been warnings from those in the contractor world that this could impact tens of thousands of workers, chasing them for sums that could run into the tens of millions of pounds.

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Can taxpayers fight back?

Crucially, this isn’t a final judgement, but more a declaration by HMRC of its suspicions about the firm and its operations.

As a result not only is Churchill Knight & Associates arguing its case, but individual taxpayers can lodge their own appeals too.

According to industry reports, the case is likely to go to a tribunal, which could take years.

As a result, thousands of contractors face the prospect of years in limbo, with the spectre of a mammoth tax bill looming above them.

That’s not just going to be a financial burden but a huge source of stress to boot.

Tax IS taxing

As someone who is self-employed, this situation is my worst nightmare and has informed the way I’ve gone about arranging my own tax affairs.

I have friends that have set themselves up as a limited company, paying themselves through dividends, and I’m confident that they are taking home a higher proportion of their earnings than I am.

By contrast, I was happy to go the sole trader route. Everything is in my name, I’m completely responsible for any losses I might make, but equally, I don’t feel like I have an arrangement in place to try to play the system.

Ultimately, the vast majority of people who are potentially going to end up paying the price here are innocent contractors, who were simply told that arranging their affairs in this way was best for their financial health.

They didn’t break any rules, they simply trusted their accountant to guide them.