Hirers, contractors and recruitment companies: is IR35 the least of your worries?

11 mins

Posted on 08 Jul 2019

Everyone and their dog knows that there are some important changes afoot with tax rules called IR35 and that stakeholders in the self-employment recruitment chain must beware if the contractor/hirer relationship is actually one of disguised employment. Fewer people know that a recent Court of Appeal case has highlighted a likely more pressing concern for the self-employment recruitment industry. 

What is the background to the case? 

In March this year, HMRC won a landmark income tax and NICs ruling against managed service companies and managed service company providers. The ruling means HMRC is able to recoup significant backdated unpaid income tax and National Insurance Contributions (NICs) without having to assess the contractor’s employment status. Industry insiders fear the ruling might spur HMRC on to pursue large groups of contractors managed by a managed service company provider. This is much easier for HMRC than having to assess each individual contractor’s employment status for each assignment. 

If HMRC takes this approach, this could affect a significant number of contractor and hirer arrangements in the UK. It could also lead to hirers and recruitment companies being liable for unpaid income tax and NICs under the transfer of tax debt rules, as explained in more detail below. 

We look at the case, how hirers, contractors and recruitment companies can reduce the risks and how we can help. 

What are the details of Christianuyi v HMRC?

This Court of Appeal case involved various self-employed contractors in the healthcare space. They appealed earlier judgments that their personal service companies were managed service companies because of their involvement with a managed service company provider. We explain below how the relevant legislation defines managed service companies and managed service company providers.

The earlier judgments meant that fees received by their personal service companies were taxable as salary and subject to NICs under the relevant tax legislation. The Court of Appeal rejected their appeals.   

What is the impact of The MSC Legislation?

The “managed service company” legislation is set out in ITEPA 2003 Chapter 9 Part 2 (MSC legislation).  Where a personal service company is a managed service company, all fees paid to it are taxable as salary and subject to NICs. The contractor’s employment status is irrelevant. The managed service company is liable to account to HMRC for income tax and NICs.

When introduced in 2007, HMRC intended the MSC legislation to tackle composite structures. These were where a service provider set up one company for various self-employed contractors. The contractors would be minority shareholders but without any say in the running of the company. The contractors would be paid a small salary and receive the rest of their fees in the form of tax efficient dividends.

Those structures were soon disbanded in the wake of the MSC legislation. Instead, many contractors moved to a structure where a service provider set up each contractor with their own company, with the contractor as the sole director and majority shareholder. However, the service provider retained the main responsibility for administering the company, dealing with compliance, running the company’s payroll systems and would benefit financially from the contractor’s ongoing services, for example by a taking a percentage of the contractor’s ongoing fees.  

HMRC has since sought to challenge these structures by pursuing such service providers as being “involved” with the personal service companies and so caught by the MSC legislation. This was the issue at the heart of the Christianuyi case.

The MSC legislation says that a personal service company is a managed service company if all of the following are satisfied:

  • its business consists wholly or mainly of providing (directly or indirectly) the services of an individual to other persons
  • 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
  • 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
  • a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals (a “managed service company provider”) is involved with the company.

The first three limbs of the test apply to the vast majority of personal service companies and so it is the last limb which is usually in dispute.  

The MSC legislation says that a managed service company provider is “involved with the company” if any of the following apply:

the managed service company provider or an associate of the managed service company provider

  • benefits financially on an ongoing basis from the provision of the services of the individual 
  • influences or controls the provision of those services
  • influences or controls the way in which payments to the individual (or associates of the individual) are made
  • influences or controls the company’s finances or any of its activities or
  • gives or promotes an undertaking to make good any tax loss.

Importantly, there are exemptions for lawyers, accountants and recruitment companies who are providing normal professional services. 

How did the Court of Appeal approach the case?

HMRC pursued personal service companies set up and administered by Costelloe Business Services Ltd (Costelloe). The personal service companies were the vehicles through which self-employed contractors provided their consultancy services in the healthcare sector. The contractors negotiated their own fees and contracted directly with end user hirers through their personal service companies. However, HMRC and ultimately the Court of Appeal considered that Costelloe was a managed service provider “involved with” those companies for the purposes of the MSC legislation.   

There was no appeal against the Upper Tribunal’s ruling that Costelloe was “involved with” the companies it set up and administered as: 

  • It promoted a contractor business services package by which it would set up and handle much of the administrative burdens for those companies 
  • It benefited financially on an ongoing basis from the services provided by the contractors (first as a percentage of fees received and then as a fixed fee)
  • It controlled the way in which the contractors set up their payroll and payment systems and how those payments were made as it operated the companies’ bank accounts 

Instead, the appeal turned on whether or not Costelloe was a managed service company provider. This depended on whether it carried “on a business of promoting or facilitating the use of companies to provide the services of individuals” and what the legislation means by this.   

The Court of Appeal agreed with HMRC’s interpretation of the legislation. To be a managed service company provider, a service provider need only promote the use of a managed service company structure. It does not also need to promote the contractor’s services to end user hirers. It rejected the contractors’ argument that HMRC’s interpretation would mean a lot of businesses who merely provide professional services to help contractors set up and run their companies, but who have no say in the services they perform, would be unnecessarily caught by the legislation.

The Court of Appeal ruled that Costelloe was a managed service company provider as it offered, promoted and facilitated the use of personal services companies to contractors. This in turn meant the personal service companies were managed service companies, with the resultant tax and NICs liabilities (without HMRC having to perform an employment status test). 

The Court of Appeal touched on the subject of lawyers and accountants. It said they are not managed service company providers if they are merely providing the normal services an accountant or professional adviser provides to a client company. In that scenario, they are not in the business of promoting a managed service company structure.

What are the debt transfer rules?

Where a managed service company found liable under the MSC legislation has not met its tax debts, HMRC can use the transfer of tax debt rules to pursue others in the chain for the amount outstanding. Those it can pursue as last port of call include the end user hirer and any recruitment companies and their directors and officers if they encouraged or were actively involved in the managed service company arrangements. This could be worrying for end user hirers and recruitment companies where such circumstances apply and where they fear the creditworthiness or the “flight risk” of other companies, businesses and individuals in the chain.  

What does this case mean for the industry?

We understand that a significant number of contractors have set up using structures provided by businesses such as Costelloe. HMRC can now target providers such as Costelloe to pursue large groups of managed service companies without having to do the employment status assessment required under the IR35 rules. This makes it easier for HMRC to chase income tax and NICs than assessing individual arrangements under IR35. Industry insiders therefore fear that HMRC may focus on the MSC legislation instead of IR35. If that is the case, a seismic shift in how contractors manage their companies will be required. 

What steps should I take to lower the risks?

Hirers and recruitment companies 

  • Do not require workers to provide their services though a managed service company arrangement
  • Do your due diligence on personal service company contractors to assess if they are operating via a potential managed service company provider
  • If they are, you may wish to reconsider the relationship to implement lower risk structures and/or seek indemnities from the contractor, their company and others in the chain in case HMRC pursues you (while indemnities may not be much use against an insolvent contractor, better to have them than not)
  • You may wish to carry out GDPR compliant credit checks on your personal service company contractors and others in the chain 
  • Include undertakings in your contractual documentation which the contractor and their personal service company sign confirming the company will comply with its PAYE and NICs obligations 
  • Include warranties in your contractual documentation which the contractor and their personal service company sign confirming they are not operating through a managed service company arrangement 
  • Include similar warranties as applicable in your commercial agreements with hirers or recruitment agents (or umbrella companies (or similar) as the case may be)


  • Do your due diligence on your personal service company arrangements if you used a service provider to set up your company and it administers most of your company’s compliance and payroll needs
  • If it seems that your business could be at risk: (i) take specific tax advice; (ii) check your terms of engagement with the service provider (and/or check with any regulatory body they are registered with) to see if you have any protection; and (iii) consider taking responsibilities for the management of your company away from these providers and take on more responsibility yourself under guidance of a relevant professional 
  • Consider your existing contractual arrangements with hirers and recruitment companies to understand what potential liabilities you might face if HMRC pursues those companies under the transfer of tax debt rules (for example, you personally may have signed indemnities, meaning hirers and recruitment companies might pursue your personal assets if you are solvent but HMRC seeks payment from them anyway)
  • Engage in constructive dialogue with your hirers and recruitment companies should they wish to restructure the relationship or change contracts to protect their positions
  • New contractors might wish to use the services of lawyers and accountants to set up their business and provide usual payroll and accounting services. They will need to take advice from these professionals on the extent to which they need to handle their own affairs to avoid falling foul of the MSC legislation 

How can Doyle Clayton help employers and employees?

We provide expert legal services to the various actors across the recruitment industry chain, including drafting and advising on the contractual arrangements at all levels. We can help with the matters mentioned above either in-house or through our trusted adviser contacts.

What are the key takeaways?

We recommend that hirer and recruitment companies carry out due diligence on the actors in their recruitment supply chain and seek personal guarantees and indemnities to reduce the risk should liabilities fall to them. They should also alert the C-Suite to the fact that IR35 is not the only pressing legal issue that needs to be addressed in the recruitment supply chain. 

Contractors might wish to consider splitting the responsibilities for who sets up and helps administer their company, they should take on more of the responsibility themselves and they should be careful of using service providers who are specifically offering end-to-end in-house solutions for personal service companies. 

These materials are of a general nature and are not a substitute for legal or tax advice. We do not accept any responsibility for the consequences of any action taken or not taken as a result of its contents. 

The articles published on this website, current at the date of publication, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your own circumstances should always be sought separately before taking any action.

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