Outsourcing: ‘Employers of Record’ arrangements targeted by HMRC to combat VAT fraud risks

The last decade has seen the emergence of the concept of “outsourcing” a workforce to an “employer of record” or a “statutory employer” or an “employer for payroll purposes”. An entity holding itself out as one of these things may say they are the “legal employer” of a worker, that they take care of payroll, administration, contracts, benefits provision, disciplinary processes, grievances and perhaps more. What they do not do is have any actual relationship with the individual in the sense of receiving the individual’s services or directing or controlling what work they provide on a day-to-day basis.

Previously HMRC has taken a relaxed view of such arrangements as PAYE and NIC were accounted for. However, criminals have worked out ways to use arrangements of this sort to carry out a form of VAT fraud and now HMRC’s Fraud Investigation Service is searching for businesses using or offering arrangements of this sort and challenging the legality of them.

An example of this includes a business being told that it had been caught up in a fraudulent scheme and were liable for millions of pounds of stolen VAT. Another is where there was no evidence VAT had been stolen, but the business was told it had always remained the employer of the workers and must immediately stop using the arrangements or face losing the right to reclaim the VAT in respect of the outsourcing services.

The employment-law perspective

The question of who is a particular individual’s employer is determined by looking both at their contract and the reality of their relationship with the person who requires and uses their services, following the case of Autoclenz Ltd v Belcher and others [2011]. It is the person acting as the employer by, amongst other things, providing work and receiving the personal service of the individual, not necessarily the person that pays the individual.

Whilst joint employment, i.e. having two employers in respect of one role, is legally possible, both of the employers would receive services from the individual in order to be employers in the legal sense. Employers of record do not generally do so.

The person acting as employer will be liable for statutory employment claims, such as claims for unfair dismissal, unlawful deduction from wages, discrimination, redundancy pay, and holiday pay. If an entity seeks to use an “employer of record” to avoid these claims, it is likely to be ineffective in doing so.

The tax-law perspective

Whilst the method of assessing whether a person is an employee of a particular party for tax purposes is slightly different, tax law still requires there to be a relationship involving the provision of personal service by the individual to create an employment relationship. If no service is provided to an “employer of record”, they are not the employer for tax purposes.

HMRC now seems to be using arguments of this sort to question the validity of outsourcing arrangements that it considers present a risk of VAT fraud.

The VAT fraud which has seemingly ended HMRC’s relaxed view of outsourcing arrangements of this sort is known as ‘missing trader fraud’. At its most simple, a criminal will set up a business to supply outsourcing services that are subject to VAT. The workers will be paid and PAYE and NIC accounted for, but later the criminal vanishes (or ‘goes missing’ in HMRC parlance) without having accounted to HMRC for the VAT. A key aim is to keep HMRC from discovering that the VAT is being stolen for as long as possible, perhaps several years, which might involve changing or adding legal entities involved in the arrangements and/or redirecting payments. There are also signs of legitimate providers of outsourcing services being targeted, seemingly to entice them to enter into further arrangements to facilitate the outsourcing services, but which may be little more than an attempt by criminals to insert themselves into the supply chain in a manner that sees the VAT pass into their hands so it can be stolen.

When HMRC eventually discovers fraud of this sort it rarely catches the criminals who are very adept at disappearing, hidden behind shell companies and false identities. Instead, HMRC seeks to shift the liability to the legitimate business that used the outsourcing arrangements by denying it the right to deduct the VAT it paid for the outsourcing services. This is on the basis that it should have known it was participating in transactions connected with the fraudulent evasion of VAT. Businesses that find themselves in that situation are shocked to find that liability can be transferred to them in that way and that they are left facing a lengthy and complex appeal process to try to challenge HMRC’s decision.

What to do

HMRC is combing the databases of tax returns, company accounts and other business records it has access to, looking for signs of businesses that have done this. It is also trying to find the businesses that provide the outsourcing arrangements and then identify their clients.

The brightest of red flags HMRC is looking for is arrangements that see the business being charged VAT on not only the fees of the outsourcing company, but also on all the payments invoiced in respect of the salary, PAYE and NIC relating to the outsourced employees. Obviously, in this case much larger amounts of VAT are being charged which can then be stolen.

Even if there is no evidence that you have been caught up in VAT fraud, HMRC may well still try to force you to immediately abandon the outsourcing arrangements, giving you almost no time to make fundamental changes to the contractual arrangements concerning your workforce.

If you need advice or have been contacted by HMRC regarding your outsourcing arrangements, please contact Matheu Smith and Helen Wyatt.