PSC Arrangements
With the raft of recent changes targeted at employment intermediaries, we are seeing an increasing number of arrangements involving the use of Personal Service Companies (“PSCs”) as a method of engaging workers.
One particular form of this type of arrangement involves the incorporation of a quantity of PSCs, each engaging either a single worker or, more commonly since 6 April 2016, two or three workers. These arrangements often appear particularly attractive to the worker due to a potential increase in their take home pay. Many of our agency clients have asked us how these arrangements typically operate and whether there are any risks to be taken into account in dealing with the organisations offering them.
It is always the case that there will be good and bad providers of any type of arrangements. This analysis is not intended to suggest that any particular set of arrangements is inherently flawed or otherwise. It does however highlight the main areas of risk to watch out for when considering using such arrangements or encouraging workers to use them.
This commentary explores the risks to agencies. There will always be significantly higher risks to a worker of dealing with any non-compliant form of employment intermediary; many areas of legislation result in the beneficiary of the income bearing personal responsibility for tax and national insurance liabilities – even where PAYE is applicable.
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Direct compliance risks to agencies
It is commonly thought that an arm’s length relationship with a PSC absolves an agency of most (if not all) compliance responsibilities. This is not the case. There are direct compliance risks to agencies dealing with PSCs, including some particular risks arising from the arrangements described above.
Incorrectly claiming the Employment Allowance
Some of the arrangements we have reviewed for clients increase the income available to the worker by advising each of the PSCs to claim the £3,000 Employment Allowance, which can be set against the PSCs’ employer’s National Insurance liability for the year.
The rules were amended with effect from 6 April 2016 so that a single person (who is also a director) company cannot claim the Employment Allowance. This may be one motivation for the recent prevalence of PSCs engaging two or three workers.
There are several restrictions governing when a PSC can claim the Employment Allowance.
Firstly, there is a Targeted Anti-Avoidance Rule which states that where any arrangements are set up simply in order to claim the Employment Allowance, it cannot be claimed. This applies even where this motivation is only one of a number of main purposes. So if the arrangements are marketed on the basis of this benefit (perhaps as part of an illustration of take home pay), it is unlikely to be compliant.
Secondly, connected companies have to share one Employment Allowance between them. We have encountered several situations whereby a large number of PSCs have been formed with the same shareholder; consequently the £3,000 allowance ought to be split across all the companies and each PSC cannot claim the full amount individually.
Thirdly, there are restrictions on claiming the allowance on some transferring-in employees. Although the rules are complex here they often come into play where workers are regularly moved between PSCs or there is a mass incorporation of former umbrella company or directly engaged workers.
Fourthly, there is a restriction on claiming the allowance in respect of functions of a public nature – this is defined more widely than might be thought and includes many sectors such as teaching and nursing.
Responsibility for deciding whether to claim the Employment Allowance should rest with the PSC itself rather than with the providers of these arrangements. This does beg the question as to who is actually running the PSCs when illustrations include the Employment Allowance by default.
The fact that it is for the PSC to claim might also lead agencies to see the issue as a problem for the PSC and nothing to do with the agency itself, and technically speaking it is certainly correct that any unpaid National Insurance liability is a matter for the PSC.
However, HMRC have publically taken an assertive stance on any arrangements that do not comply. HMRC’s Spotlight 24 bulletin claims that:
HMRC’s firm view is that such schemes are notifiable under the Disclosure of Tax Avoidance Schemes (DOTAS) rules. Anyone who comes within the meaning of a promoter for such a scheme who has not notified it under the DOTAS rules could be liable for a fine of up to £1 million. The definition of ‘promoter’ under the DOTAS rules goes beyond those who devise the scheme itself.
It includes people who:
- make a firm approach to another person with a view to making a scheme available for implementation by that person or others
- make a scheme available for implementation by others
- organise or manage the implementation of a scheme
Whether HMRC’s position is correct will depend on the particular facts of each case, but it is certainly not beyond the bounds of possibility that an agency promoting a scheme to its workers could come within the second bullet above and therefore this should be seen as a direct risk to an agency, and the necessary due diligence is advisable.
VAT Flat Rate Scheme issues
Another typical feature of the arrangements described above is that each PSC is encouraged to register for the Flat Rate VAT Scheme (“FRS”) in order to generate some further income for the PSC and thus for the worker. In some arrangements this is a key component and the PSCs are all registered by default.
Registration for FRS can be withdrawn by HMRC if it turns out that the PSCs are associated with another company. Association is defined as being under the dominant influence of the other company, or being closely bound by financial, economic and organisational links.
Clearly this is a risk here where there is a ‘scheme provider’ calling all the shots – particularly so where FRS is key to the arrangements and PSCs are registered by default by the provider.
In some cases the position is arguable, but in many cases we have reviewed there is blatant association between the PSCs and the provider. In particular those arrangements whereby the purported directors of the PSCs have no actual involvement in running the company (in some cases they are based entirely offshore, presumably to try to remain out of reach of HMRC’s grasp) expose a significant risk.
Again it might be thought that a PSC’s VAT liability is an issue for the PSC and not for the agency engaging with the PSC. However this is only part of the story.
Some of the arrangements described above are a flagrant abuse of FRS, and involve deliberate obfuscation of the true ownership and management of PSCs. Such arrangements are potentially fraudulent in nature, and will no doubt be challenged by HMRC in the future.
Insofar as the fraudulent evasion of VAT is concerned, where it can be shown by HMRC that an agency should have known that the transactions it entered into were connected with any fraudulent evasion of VAT, the agency will lose its right to recover the VAT incurred on those transactions. This could clearly amount to a very significant liability to the agency.
HMRC recommends that due diligence is undertaken in accordance with its published guidance. A failure to carry out appropriate checks will be one of the factors that HMRC will take into account in considering whether the agency should have known of the fraud.
Other issues
The due diligence recommended by HMRC is good practice for many other reasons. Transparency over the supply chain and the way in which workers are engaged and paid is vital in order to ensure that any compliance risks are understood and addressed.
Agencies remain potentially liable for several regulatory aspects of workers engaged by PSCs. Liabilities can arise under the onshore intermediaries rules (Section 44 ITEPA 2003) depending on exactly how the worker is paid, the offshore intermediaries rules, the Agency Workers Regulations, the Managed Service Companies rules, and the recently amended travel expenses legislation.
These last two pieces of legislation include specific debt transfer rules widening liability to those who encourage or are actively involved in the arrangements – and may include personal liability for directors of agencies.
We would stress again that with proper due diligence an agency may be satisfied that there is no risk and that a particular set of arrangements is compliant – however it would be foolhardy to rely on an assertion from the provider of the arrangements without checking the position.
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Commercial and contractual risks
As well as the direct risks of the liabilities mentioned above, there are other potential aspects of the arrangements that agencies should be considering.
Contracts between agencies and PSCs or providers of arrangements should be carefully vetted for indemnities, warranties or clauses which expose the agency to the various debt transfer provisions. We have seen more than one example where a so-called ‘warranty’ given by a supplier to an agency is in fact worthless to the agency but contains terms exposing the agency to liabilities.
An obvious problem of dealing with a non-compliant intermediary is the risk that the company will become suddenly insolvent as a result of HMRC compliance activity and as a result funds will not reach the workers. Where this happens it is usually the agency that has to pick up the unpaid wages bill on a ‘goodwill’ basis for the sake of business continuity.
There are other operational risks to consider: the disruption to workers and clients from an HMRC investigation; and the all-too-common issue of workers being inappropriately set up in PSCs and being left with the burden of Companies House and HMRC filing responsibilities once the engagement has ended or the supplier has left the arena. Non-filing penalties accumulate disconcertingly quickly in this scenario.
Finally, there is reputational damage to consider. Agencies seem to be flavour of the month for undercover exposés recently: indeed the arrangements described in the Spotlight 24 bulletin were the subject of a BBC programme and featured in several other media outlets.
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Summary
Providers of PSC arrangements come in all varieties, with varying attitudes towards and investment in compliance. As previously stated, this analysis is not intended to suggest that there are necessarily risks in such arrangements.
The key to a successful and risk-free relationship is to understand the danger areas of non-compliance and to conduct the appropriate due diligence checks.