Article by Robert Tsang and Helen Athey of Arthur Andersen, published in the April 2001 issue of "Tax Adviser".
The rising cost of using temps The eagle-eyed amongst you may have noted that the Department of Trade & Industry (‘DTI’) issued revised regulations affecting the recruitment and temporary worker markets at the beginning of February. What’s the tax angle? There’s a clue in the supporting documentation to the Conduct of Employment Agencies and Employment Business Regulations (on the DTI website at the government’s regulatory impact assessment recognises that the financial sector will face additional costs of up to £25 m p.a. as a result of new regulations on the conduct of employment agencies and ‘the removal of the existing provisions allowing employment agencies to offer “VAT efficient” arrangements’.
Many partly exempt businesses currently use agency structures when taking on temporary staff, whereby temps provide their services to them free of VAT. Under these arrangements, employment agencies disregard remuneration paid to the temp by the hirer (including salary, NIC, pension contributions and similar payments) in determining the value of their supplies for VAT purposes and the partly exempt customer incurs VAT only on the employment agencies’ charges.
These arrangements are now fairly widespread. However, Customs have taken the view that the VAT saving is about to be removed when the DTI’s draft regulations become law. At the time of writing, Customs have not yet published their reaction to the new regulations, but no doubt their views will be made known shortly.
VAT history through the UK courts
The opportunity for partly exempt businesses to gain a VAT saving derived from the High Court decision in Reed Personnel Services [1995] BVC 222. Reed was an employment agency that supplied nurses to hospitals; Customs argued that Reed was making VAT exempt supplies of nursing services, which would not entitle it to recover the whole of its input tax. The matter initially went to the VAT and Duties Tribunal
(No. 11,065) where it was found that Reed was merely acting as an agent for the nurses, who were supplying their services to the hospitals as independent principals. The decision was upheld in the High Court; following this case a number of employment agencies then adopted ‘Reed agency models’ allowing temps to provide their services to partly exempt businesses free of VAT.
The decision in the case of Hays Personnel Services Ltd [1997] BVC 4,106 goes in another direction: the tribunal found that Hays was not just introducing staff in return for commission but also deducting tax under the PAYE system in relation to temps’ wages. Here, the tribunal decided that Hays had been acting as an independent principal and had been supplying temporary staff for a ‘unitary charge’. This meant that it had to account for VAT on the full value of payments relating to the supplies, including the wages it paid to the temps.
Following high profile employment agency cases and fearing the ‘opening of floodgates’, Customs issued a Statement of Practice (‘SOP’) outlining new arrangements that would apply from 1 April 1997 to 31 December 1998 in relation to the ‘Hire of staff by employment businesses’ (Part A of the SOP). This sought to define the specific circumstances under which employment businesses could disregard wage-related costs in valuing supplies made to their customers. The SOP also contained additional ‘concessions’ which applied to genuine secondments and the placement of disabled workers and these are not expected to change as a result of the new DTI regulations.
DTI review of employment relations
In September 1998, the DTI announced a comprehensive reform of the recruiting/temp agency industry with the aim of giving more employment rights to temporary workers. It issued a consultation document in May 1999 together with draft legislation. Customs responded by issuing guidance in September 1998 and June 1999 (BB 20/98 and BB 13/99). These publicised Customs’ view that the new legislation would make the ‘Reed agency model’ redundant as all temps would then, according to Customs, be employed by the employment agencies for VAT purposes.
In VAT terms, all supplies made by employment agencies of temp services would only be as principal and VAT would be due on all the related costs (including wage-related payments). Customs announced a temporary extension of the ‘staff hire concession’ (i.e. Part A of the SOP) until the employment changes were put in place. However, they stated that the concession would be withdrawn on implementation of the employment changes.
Draft conduct regulations 2001
Following the initial consultation period, the DTI finally published its draft regulations on the conduct of employment agencies and businesses last month. According to these regulations, it will be unlawful for an ‘employment agency’ to pay a worker any remuneration arising from their employment with a hirer to whom the agency has introduced them. Temporary staff hire services must in future be provided on an ‘employment business’ basis.
The new conduct rules are planned to be effective from summer 2001. This may be ambitious given that there is now likely to be a general election held in the next few months, which will inevitably delay the path of the legislation through Parliament.
Customs’ likely interpretation?
Although Customs have not, at the time of writing, formalised their response to the DTI publication, it is unlikely that their views will have changed since issuing BB 13/99. The effect of the regulations, which are now before Parliament, is not significantly different from that of the draft regulations published as part of the DTI’s consultation exercise in 1999. Customs are fully expected to issue guidance on this matter in the near future which will withdraw Part A of the original SOP and require employment agencies to account for VAT on the entire supply to its customers.
Customs are likely to apply the new VAT rules from the date the conduct regulations become effective. The new rules are likely to apply equally to new contracts and contracts in existence on that date. ‘Agency’ arrangements based on the Reed decision that are properly implemented will probably continue to be accepted by Customs until the new legislation comes into force.
What does this mean for employment agencies?
Employment agencies need to be prepared for this inevitable change in Customs’ treatment of supplies of temps by employment agencies – particularly in ensuring that existing contracts allow them to charge additional amounts of VAT. Some employment agencies may choose not to comply with the new legislation, instead relying on the Reed case to decide the treatment of their supplies. Arguably a change in employment law does not, of itself, necessarily change the VAT treatment. If the underlying facts do not change, why should the existing VAT treatment change? The nature of the services provided by employment agencies will not change by virtue of the employment regulations; however, Customs are likely to challenge any contrary interpretation of the legislation in the courts.
Withdrawing VAT efficient schemes before competitors could lead to a competitive disadvantage particularly in VAT sensitive markets such as the finance sector. However, there may be opportunities to target new clients or improve existing relationships by developing alternative VAT efficient arrangements.
Effect on partly exempt organisations?
Many partly exempt customers currently benefiting from VAT efficient arrangements for hiring temps may be unaware of the impending changes about to hit their industry. Where clauses in existing contracts reserve an agency’s right to charge an increased amount of VAT following legislative changes, this may leave partly exempt businesses with an unexpected VAT cost. This will be particularly noticeable in cases of short notice periods and where few steps are taken to address the impending changes before they happen.
Partly exempt businesses may wish to speculate on alternative VAT efficient ways of structuring contracts for the provision of temps. Some alternatives could include restructuring contracts of employment to ensure that temporary workers become employees of the customer. Remuneration and other related costs would be paid by the customers (and be free of VAT) and would therefore not represent consideration for supplies made by the employment agency. Other ideas include joint venture planning involving VAT grouping so that services relating to temporary staff are provided free of VAT. However, Customs have recently issued guidance outlining
their intention to challenge arrangements of this nature.
Another alternative is to re-examine the nature of the employment agencies’ services with a view to exempting outsourced financial services. This is also an area of contention for businesses and tax authorities around Europe, following a number of high profile cases.
What’s next
With a limited number of alternatives and ever-increasing scrutiny from Customs, partly exempt businesses will probably continue using Reed model arrangements for the time being. The substantial amounts of tax at stake may make it worth their while resisting challenges to the Reed model and persuading employment agencies to argue their case through the UK courts, and probably beyond to the European Court of
Justice. On the other hand, employment agencies have much to lose by not complying with Customs’ expected guidelines and little to gain if they act in line with their competitors in implementing the new VAT rules. As usual, watch this space…
One thing is certain in today’s environment. The sooner you are aware of changes in regulation that may impact adversely on your VAT costs, the better you are prepared to deal with the consequences.
Technical Department
020 7235 9381
April 2001 by
