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Composite Companies

Composite Companies On the 6th of December 2006, the Chancellor's pre-budget paper revealed a raft of proposed legislation called "Tackling Managed Service Companies", which if made law, will spell the end of Composite Companies.
With the Intermediaries Legislation (known as IR35) having proved ineffective in levelling the playing field, the industry is still witness to wide scale non-compliance costing the Exchequer an estimated £350 million in tax revenue. This latest proposal is a 'second effort' to remove what the Chancellor sees as an "unfair competitive advantage" that Managed Service Companies (MSC's) provide to their member contractors.

What is a Composite Company?

Like an Umbrella Company, a Composite Company is a managed service provider to contractors and freelancers who seek a hassle free alternative to running their own Personal Service Company (PSC). There the similarity ends, for more on PAYE Umbrella Companies, click here.
  • So what is the problem with Composites?
    The problem in the Chancellor's view, is that their members are 'wrongly' being offered tax advantages that belong to those who are genuinely in business. The point that HMRC make, is that workers using MSC schemes are not in business of their own volition, but are actually in employment. And as employees they should be taxed at salaried levels. In spite of IR35, this is not happening.
    Please note, that a PAYE Umbrella Company does not offer such "tax advantages" and therefore is not the target of this proposed legislation.
  • Characteristics of a MSC
    Every Composite structure has a MSC scheme provider and a number of companies underneath it. The scheme provider mass markets its system to contractors and handles the administration and management of the companies underneath it on an ongoing basis.
    The scheme provider will at the outset, set up the Composite Company and determine the number of shareholders. It will set up and manage the bank account of the Company, and principally determine the greatest take home pay for the contractor. This further involves the retention of PAYE, NIC's and corporation tax, which are paid to HMRC as and when they become due.
    Within each Composite Company will be found several unrelated contractor/ freelancers, who are made shareholders. This is done to qualify for the tax advantages that business owners are entitled to.
  • How do Composites get these "tax advantages"?
    Below a schematic of what a typical Composite structure would look like:
    Composite Company structure
The Composite Company operates as follows:
  • Each contractor gets paid a salary at the National Minimum Wage, labelled A1, B1 and C1 in the diagram. The workers pay income tax and employee's National Insurance Contributions (NIC's) on this salary and the Composite Company pays employer's NIC's.
  • The remaining remuneration for each worker is subject to corporation tax as the profit of the Composite Company and then paid out in dividends.
  • Each worker usually has his own share class paying out dividends, labelled A2, B2 and C2 in the diagram.
As long as they are basic rate tax-payers, there is no income tax due on these dividend payments, and there is no NIC's charge on dividend income.
Proposed MSC Legislation
IR35 was unsuccessful in addressing the problem that is Composite Companies, due to resource intensive nature that IR35 requires for enforcement.
This proposed legislation is aggressive in nature and at first reading, appears as though it will be very effective in dealing with MSC's. For further reading on this legislation, read here.