The Times highlights tax avoidance in the staffing supply chain
19 June 2012
Action needed now to minimise reputational and financial risk for staffing companies.
The entire front page of today's (19 June) London Times consists of an expose of "tax counsel approved" offshore payment schemes for various types of people working in the UK. This group obviously includes contract workers – the Times reporter leading the story posed as an IT consultant. The Times promises more exposes over the next few days.
These sorts of tax schemes are quite common in parts of the staffing industry, often massively reducing income tax/PAYE and social security/NICs charges relating to contract workers. We have in particular heard of IT, healthcare and engineering contractors using these types of arrangement, and most sophisticated staffing companies are now aware of the issue.
For years good staffing companies have been telling us how unfair it is that they take steps to avoid engaging contractors paid under risky schemes only to find less careful or scrupulous competitors "helping" contract workers to use them to their great commercial advantage. The main problem of course has been that the UK tax authority (HMRC) has not had the manpower or budget properly to review all the arrangements.
But risk in this area now seems to be growing. Following comment before today from newspapers supporting all both major UK parties, and recent comments by the UK Chancellor, George Osborne, about the "moral repugnance" of these schemes, we believe HMRC will now come under significant political pressure to make examples of promoters, users, and beneficiaries of tax avoidance schemes for contract workers (including umbrella workers and personal service company contractors and sole traders).
Even if there are relatively few major HMRC investigations, it seems likely that hirers will be alarmed and become more demanding about eradication of tax risk in the supply chain. It also seems that in M&A transactions, staffing company owners will face increasing scrutiny by potential purchasers of what tax practices they and their contract workers have been involved in. As has been previously reported private equity buyers and US buyers do not like to inherit this sort of historic tax risk.
Action is therefore needed now to minimise risk for hirers and staffing companies relating to the way their contract workers are paid.
What do staffing companies (and hirers) need to do?
The key risk for hirers in relation to offshore schemes is that, under s689 of the UK Income Tax (Earnings and Pensions) Act, HMRC have the right to assess the hirer for PAYE and NICs where the agency worker has been paid offshore. Many staffing companies check this sort of thing out so far as possible, to minimise risk for hirers. Others don’t, often unaware of the problem. Some staffing companies even help encourage use of the arrangements in order to attract the best contract workers to their books (and thereby make more money). A few staffing companies probably even get a payment back from the scheme promoters, perhaps by way of a share in the overall tax-saving.
Hirers may ask for a tax indemnity from their staffing company covering likely liabilities (and even if they don't will probably expect the staffing company to pay the tax under a duty of care), and so s689 is a risk issue for staffing companies as well. Staffing companies cannot insure against those claims, and so claims will have to be funded from balance sheet. This is obviously a serious problem: 10 long term contractors via one staffing company @£200k per annum each = potential £1m tax assessment = greater than the balance sheet strength of many mid-tier staffing companies.
The Times coverage of these issues comes on top of:
- The insolvency of Rangers FC following, amongst other things, a tax assessment arising from use of an offshore Employee Benefit Trust ("EBT") scheme with many similarities to that exposed by the Times today.
- The Huitson case of 2010, which left an IT contract worker (and other so-called self-employed consultants) facing a £100,000 tax bill. It has been reported that the contract workers encouraged HMRC instead to pursue the end-hirer under the s689 tax debt transfer provisions.
- The £158M assessment against Reed by HMRC for an expenses scheme for agency workers paid under an umbrella model set up by a large accountancy firm. This scheme appears to have failed to satisfy key legal tests relating to "mutuality of obligation" between assignments. If Reed or any other operator of an umbrella scheme facing such a liability becomes insolvent, workers may well be left unpaid and are likely then to seek payment from hirers and/or staffing companies. This happened after Albany failed.
- The UK Government’s proposed GAAR legislation which may effectively make all schemes which try to hide the true nature of an employment relationship subject to full PAYE and NICs (including on expenses).
- The UK Government’s proposed “controlling persons” legislation making hirers liable for PAYE and NICs in respect of personal service company contractors supplied via staffing companies to hirers and who have some element of “control” of part of the hirer organisation or workforce (perhaps including project managers and interim managers – clearly lots of lobbying will be needed on this in order to make sure the final legislation is clear about who is caught).
- Increased activity by HMRC under the 2007 Managed Service Company tax legislation (which again allows transfer of contract worker tax debt up the supply chain).
- Revised (albeit much-criticised) HMRC guidance on the application of IR35, with HMRC clearly taking the view that (so far as they are concerned) most contract workers are not really self-employed.
So we consider that hirers will step up the checks they require MSPs and preferred suppliers to carry out on contract workers and hirers are likely to ask the following questions:
- Does the balance sheet strength of the MSP and preferred suppliers cover the size of tax claims against the hirer under s689 of ITEPA?
- What checks do the MSP and preferred suppliers carry out to check that contract workers are not paid offshore via EBTs or otherwise?
- What checks have they carried out to make sure the umbrella expenses schemes used by their agency workers will not fail if the Reed principles are applied to them?
MSPs and preferred suppliers will in turn instigate closer checks on the payment arrangements of contract workers. Many of course are already very careful and what we expect is a general levelling-up involving checks and spot checks (copy bank statements etc.) on:
- how personal service company contractors are paid; and
- umbrella expenses schemes (including checks by lawyers on "mutuality of obligation" arrangements). See our previous publication for guidance on this.
And, as if these tax issues were not enough, later this summer hirers and staffing companies will need to start working together to identify how contracting models need to be changed to:
- reduce cost resulting from the GAAR;
- reduce cost resulting from the “controlling persons” legislation; and
- implement whatever arrangements work best (on a hirer by hirer and worker-type by worker-type basis) for the purposes of implementing Pensions Act auto-enrolment.
A final point: many of the offshore tax schemes we have come across market heavily the fact that "leading tax counsel" has given his seal of approval. This may of course just be a lie. Often however it will be true that tax counsel has helped advise on the merits of a scheme. The problem then might be that the advice may well have predated crucial law changes. The advice may also primarily have focussed on the immediate risks of the scheme to those promoting or directly involved in it, rather than on risks for the wider supply chain including hirers. Last but not least, just because someone tells you tax counsel has approved something does not give you the right to sue that tax counsel if the scheme falls apart. Therefore all involved in the supply chain need to be aware that tax schemes "approved by tax counsel" may not be safe for everyone or at all, and that you need to carry out your own checks. If it sounds too good to be true, it may well be.
If the worst comes to the worst and you face a claim relating to an offshore EBT scheme then please contact us. We are aware that HMRC are looking for opportunities to settle cases where trusts have been used for anti-avoidance purposes (see previous publications here and here), particularly in light of the new disguised remuneration rules. Our tax team has helped several companies consider the right settlement/defence strategy for their arrangements and ensure that any future planning remains robust.
If you have any concerns or want help we would urge you to contact us immediately – we have clear guidance you can follow to minimise risk, and preserve the value of your company.
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