This article has been updated
Judges have ruled that umbrella provider Exchequer Solutions owes HMRC £11m in unpaid tax, but will contractors end up picking up the tax tab? We ask the experts to see what they think and their tips to contractors.
The article covers:
- What is the Exchequer Solutions case all about?
- Overarching v. individual project contracts: know the difference!
- How could this have been avoided?
- Will contractors have to foot the bill?
- What happens to umbrella companies in big legal battles?
- Can umbrella contractors expect higher fees & what should umbrella contractors do next?
What is the case about and why has it sparked so much interest?
The legal report on the case, Exchequer Solutions Ltd. V. HMRC, highlights right off the bat that the way in which individuals are engaged in the construction industry is “not straightforward”.
In many cases, the individual is not employed directly by the contractor who is responsible for the construction project. Instead, the contractor will enter into an agreement with an agency so that workers can be found when they are needed.
The report continues to explain that the agencies however may not want to take on the responsibility of acting as an employer. They will therefore enter into an agreement with companies such as the appellant, Exchequer Solutions Limited (“ESL”) under which the agency becomes a client of ESL. ESL fulfils its obligations to the agency by providing the services of the construction workers which it takes on as employees.
ESL as the workers’ umbrella company will aim to act as the employer of the relevant individuals across multiple assignments and not just in respect of one particular job. This is where things seemed to have gone wonky.
Exchequer told The Freelance Informer in a statement that they had workers sign a single contract of employment which then remained in place for all work done for ESL, the company did not require contractors to sign a new contract for each assignment (see para 74 of the ruling).
The Judge found that a separate contract of employment effectively arose for each assignment as there wasn’t sufficient mutuality and control in place at all times (see para 201 of the ruling).
Exchequer’s Managing Director, Mike Lowndes, told The Freelance Informer the umbrella will be appealing the latest outcome:
We operate in a technically complex industry and have continually sought financial advice from the UK’s leading tax advisers. There is no statutory definition of an overarching contract, so this matter is a technical argument on employment law and tax.
We feel that HMRC’s approach to this matter is an attack on the umbrella industry as a whole and would like to extend our support to our peers within the industry.
Whilst we are extremely disappointed by the ruling, we will be appealing the outcome and would like to thank our dedicated team, clients and partners for their continued support.
MOU and sector differences
By the nature of the recruitment sector when it comes to construction and the end client, there is often very little client control over how a highly skilled worker carries out their work. But if a worker is signing different contracts for every project they carry out on behalf of the recruitment agency and umbrella company, then they are not deemed employees of the umbrella and therefore should not be submitting expenses to the umbrella. But if you are an umbrella company worker, then you are an employee, right?
This is why even experts scratched their heads about this case.
Overarching v. individual project contracts: know the difference!
The key issue in this appeal is whether ESL employs the relevant individuals on a continuous basis under an overarching or umbrella contract of employment which covers all of the various assignments undertaken by a particular employee through ESL and includes any gaps between those assignments (including periods where the individual may be working for another employer) or whether there is a series of separate contracts of employment in respect of each individual assignment.
The importance of the distinction lies in the entitlement of the employees to be reimbursed for travel and subsistence expenses without that reimbursement being subject to tax or national insurance contributions (“NIC”). If there is an overarching contract of employment, each place of work is a temporary workplace and the expenses can be paid tax-free. However, if there is a separate employment contract for each assignment, the workplace is a permanent (albeit possibly short-lived) workplace and any payment in respect of expenses remains within the scope of tax and possibly NIC.
Having carried out investigations, HMRC’s conclusion, in this case, is that there is no overarching contract of employment so the payments relating to expenses are subject to income tax under the PAYE system and to NIC.
“This case hangs off the concept of mutuality of obligation, which was recently clarified by the Court of Appeal in both HMRC v PGMOL, and HMRC v Atholl House. Without there being sufficient ‘employment related’ obligations in the gaps between assignments, the overarching umbrella contract cannot be one of employment. Instead, each assignment is a separate employment,” says Dave Chaplin, CEO of ContractorCalculator.
“The impact of this is that the umbrella company was not right to allow tax-deductible expenses for the ‘employees’ and the income was instead earnings, and tax should have been paid,” he says.
Chapilin notes that it has not gone unnoticed that the umbrella company has accreditation by umbrella group the FCSA, which states on its home page that ‘FCSA members are fully compliant with tax and employment laws.’
It appears this may not be a true statement and it may be prudent for them to review their claimed ‘gold standard’Dave Chaplin of ContractorCalculator
How could this have been avoided?
Crawford Temple, CEO of Professional Passport, an independent assessor of payment intermediary compliance says the latest legal battle involving an umbrella company that has operating outside the acceptable rules has been “disappointing to learn”
“Each time we hear about such stories the whole industry and supply chain takes another knock,” says Temple.
“This latest case serves to highlight why HMRC needs to work more closely with compliance bodies and the wider sector to ensure that standards are reached, raised and maintained across the whole supply chain,” he says.
He notes that the change to the rules in 2016 saw the removal of dispensations for the umbrella market to receipted rates and HMRC would challenge that as this case shows. “Professional Passport does not allow any of its providers to operate benchmark rate expenses and they only operate receipted expenses,” he says.
Temple also says that recruitment agencies should be more vigilant when it comes to the relationship and documentation between recruitment companies and umbrella providers.
“This ruling should serve as a clear warning to any umbrella provider who operates expenses for workers, especially where there is a reliance on those workers operating outside of Supervision, Direction and Control,” says Temple.
Will contractors have to foot the bill?
Julia Kermode, the founder of IWORK, an information source for all independent workers, explains why this type of operation where umbrellas provided tax-deductible travel and subsistence expenses to their workers was legitimate and fairly standard during the tax years in question. Yet, at this stage, she believes contractors appear to be unaffected.
“Due to the law changes in 2016, only a tiny proportion of umbrella workers will currently be eligible for tax-deductible expenses and it is likely that you would know if this applies to you. If you aren’t sure, check your payslips for anything that isn’t taxable pay and ask your umbrella if you see anything unexpected in your pay,” says Kermode.
What happens to umbrella companies in big legal battles?
Chaplin tells The Freelance Informer that it is the umbrellas themselves that will be facing large bills. This is where umbrella workers may have to start looking for a new umbrella as those umbrellas looking like they may have to make a large payout as in this case, ultimately could make them insolvent, says Chaplin.
“Because of the phoenixing rules the [umbrella] directors will be unable to set up a new company as the tax bills will be passed on to any newly formed company. And the umbrellas will not be able to recoup the expenses from the contractors,” he explains.
What should umbrella contractors do next?
When asked if umbrella fees could go up as a result of umbrella legal cases with HMRC, Chaplin has this to say:
Fees could rise but that would put an umbrella at a commercial disadvantage and contractors would simply choose an alternative provider.
He also offers some tips: “My advice to contractors is to write to their umbrella provider and ask for specific clarification regarding how their chosen umbrella operates their expenses policy and ask whether they are doing anything that is contrary to the ruling that has been made. Every compliant provider has to follow the same rules and the only savings would be marginal, just a few pounds a month difference. Contractors should conduct due diligence and ask questions.”
This case concerns legislation that was in place prior to a rule change in 2016 so most umbrellas are unlikely to be operating this type of expenses model today.
“However,” says Chaplin, “how many more umbrellas will we see facing HMRC in court? Contractors might also be wise to ask their umbrella provider if they are currently under investigation and facing an enquiry.”