After the MSC legislation what should contractors do with existing contracts?

In the light of the Managed Service Companies (MSC) legislation in the recent Budget, what options do contractors have open to them with their contracts and what should they do to make sure they are compliant?

The Best Option: Umbrella or Ltd Company?

For contractors starting out and choosing to go through a PAYE umbrella, it is vital to ensure that any expense payments on offer can actually be claimed. Says Kate Cottrell, Co-Founder of Bauer & Cottrell: “It is highly likely that HMRC would view the workplace as a permanent one, so unless a contractor is required to travel to a temporary workplace no travel and subsistence payments are possible, and without these this option is not very attractive.”

Opting for the limited company where they would have full financial and management control, then perhaps the biggest issue is IR35 and any contract needs to be checked to see if it is inside or outside the IR35 legislation. “It is worth doing some sums before deciding between an umbrella option or a limited company. This includes umbrella with and without expenses, and limited in and out of IR35,” adds Cottrell.

Moving Providers

According to Chris Lee, Head of Business Tax at James Cowper, the contractor may be able to drop their MSC and move to a Personal Service Company (PSC), but this will depend upon the terms of the contractor's contract with the agency and whether they can practically make the change in the short time available. However, because the NIC regulations on MSCs are not expected to be implemented before August 2007, it seems likely that many contractors will continue to use MSCs until then.

“The overall tax burden will be slightly higher than under the pre-MSC regime, but there will still be a worthwhile overall saving, most particularly for contractors who do not claim significant expenses,” he says.

But, according to John Chaplin, Director of Taxes at KPMG LLP, given the changes announced on Budget day and clarified in the guidance notes published last Thursday, it's unlikely that many informed agencies will be happy to accept contractors providing their services via PSCs promoted by a managed service provider.

“Some providers are relying on an exemption in the legislation for ‘accountancy services’, but I don't believe that this holds water. Some of the bigger providers have already announced a move away from PSCs to umbrella companies and I'd expect that more and more agencies will demand this approach,” he says.

According to Kate Cottrell, if the MSC has signed a contract with an agency or directly with an end client to provide the contractors services this is a legally binding document. “It will be necessary to look closely at the termination provisions including notice periods with particular attention being paid to potential breach of contract and any penalties for the same,” says Cottrell.

Can Contractors Insist On Changing of Provider?

Legally, it depends on the contracts entered into, but John Chaplin feels that most agencies will be happy to allow a change to a compliant provider without being too worried about what the contract might say - particularly if they could be putting themselves at financial risk by not doing so.

“I'm expecting a fair bit of movement between providers as they vie for customers. What contractors need to be wary of is jumping ship without understanding how their existing provider is managing the process, how the new provider will deliver on promises and how their accounts will be prepared by the old provider,” says KPMG LLP’s Chaplin. “Many of the providers are still coming to terms with the changes themselves and some are saying things which are, frankly, technically misleading at best.”

Can Contracts Be Renegotiated to be Outside IR35?

If they have their own limited company without any MSC provider involved, then this could potentially save them quite a bit of tax and is possible. “If an MSC is involved, then it's pretty irrelevant as PAYE will be due anyway,” says John Chaplin. “However, IR35 depends on the working practice as well as any contractual relationship. Given this, and the current interest surrounding MSCs and IR35, I would caution any contractor to be wary of renegotiating a contract simply to avoid IR35.”

And The Short Notice Period?

Contractors may have less than their normal termination clauses (4 weeks) in which to make the necessary changes. Some contractors are concerned about managing their tax affairs for that period. Will they be chased for further tax?

Says John Chaplin: “The legislation hasn't yet received Royal Assent and so it could change. Also, I'm not sure how easy it would be or how much appetite HMRC has to chase up on PAYE liabilities for tens of thousands of contractors who may or may not have a PAYE liability. My own view is that they will take a pragmatic approach as long as things are put right ASAP after the legislation is finalised but there can be no guarantee of this.”