Staffing companies face a busy legal agenda and emerging M&A risks in 2022
Published on 15th Dec 2021
What developments will likely cause the most concern for investors and end clients of staffing and workforce solutions companies as they enter the new year?
Digitalisation, decarbonisation and the ongoing waves of the Covid-19 pandemic have made business planning an uncertain exercise in 2021. Many organisations faced with these factors as they head into 2022 are increasingly looking at flexible workforce arrangements and contingent workers. But the new year looks set to promise a number of legal and tax developments that will require users and suppliers of flexible workforces to look hard at their engagement models and labour supply chains.
In recent years, there has been an increase in the use of flexible workforce models, which allow for the temporary or seasonal or remote hiring of specialist workers. In November 2021, the Financial Times reported that the number of people in England and Wales working contingently has trebled over the last five years: three in 20 adults found work this way at least once a week in 2021.
At the same time, the legal landscape relating to contingent working is becoming more complex in many countries. This has not stopped many organisations from relying more and more on contingent workforce arrangements – and there are many knowledge workers only available on this remote or occasional basis, whether self-employed contractors, agency workers, zero-hours workers, gig-platform workers or other workers. But end users and investors are becoming concerned about these legal and tax changes, and there are a number of areas now regularly coming up as a key part of due diligence exercises on private equity and strategic investments in workforce solutions companies.
Use of umbrellas and 'employer of record' companies
It is well documented that organisations are increasingly using umbrella companies and US-style employer of record models as a model of engagement.
The government has now issued "Call for Evidence" about how "umbrella companies" – employment intermediaries that are similar to US professional employer organisations (PEOs)/employers of record – operate and what is bad (and good) about them. The document confirms the government's commitment to bringing umbrellas under the regulatory regime (with criminal sanctions) currently administered by the Employment Agencies Standards Inspectorate. It makes clear that there will be further regulations to deal with non-payment of workers, skimming of payroll and non-payment of holiday pay by umbrella companies. It is noted that accreditation by an industry body is not a guarantee of compliance.
At the same time, HMRC is targeting the use of "dodgy" umbrellas and has stated that some models they use (often involved in low-pay situations) involve "tax fraud". As such, end users and staffing companies, which heavily rely on relevant umbrella arrangements, may be liable for unlimited fines if they cannot show that they took reasonable steps to prevent the tax evasion.
None of this changes our view that the umbrella/employer of record model, when properly operated, will, in most countries, play a valuable part in enabling organisations to use flexible workforce models, and the better operators will welcome the prospect of regulation to help them differentiate from the "dodgy" end of the market. But, in the meantime, users of umbrella/employer of record models will have to be ready for investors and end clients to ask a lot of questions.
IR35: increased enforcement activity by HMRC?
Many organisations looked hard at their use of personal service company contractors (PSCs) in the run-up to the April 2021 changes in the UK to IR35, and, in many situations, there has subsequently been a reduced use of PSCs. There are reports of many now putting their feet back in the water and engaging personal service company contractors again (after initial end-client decisions to blanket-ban use of them).
We know that some end users and staffing suppliers are relying on output-based "statement of work" (SOW) assignments to claim that the SOW services operate outside IR35 and therefore remove IR35 risk. This may be the case where the SOW is a genuine SOW with scoped deliverables and payment on delivery (rather than for time spent) but anything that falls short of that risks not being regarded by HMRC as what it calls a "contracted out" service and would be subject IR35 rules.
There are also reports of companies assuming that Construction Industry Scheme supplies by personal service company (PSC) subcontractors will always fall outside IR35: this is not the case because IR35 will apply unless the supply is a genuine contracted-out supply, similar to a SOW.
We are also hearing that some companies are becoming complacent or sceptical about IR35 risk thinking on the lines of: "it's actually not that much of a worry, and we need the best contractors so let's relax our rules". The reality is that HMRC has four years to raise pay-as-you-earn assessments – six years for National Insurance contributions (NICs) – and often issues protective assessments before the end of the fourth year; the point being that we may not see any enforcement under the new rules until March 2025. But, by then, the assessment will be for four years' worth of tax and NICs. We're also aware that HMRC sent out a number of tax compliance letters earlier this year to offer reviews of companies' IR35 compliance procedures so it's possible that enforcement action will be taken quite soon in relation to any underpayment of tax and NICs uncovered as a result of those "reviews".
HMRC is currently gathering data about volumes of PSCs paid "outside IR35", that is, without deduction of tax. The honeymoon period is over. We expect to see some tax assessments raised against fee payers (and, possibly, end users) who have not "got on top" of IR35 compliance. This could include:
- failing to issue Status Determination Statements with "reasonable care";
- reaching "outside IR35" decisions based on an over-reliance on substitution "rights";
- placing reliance on an absence of "mutuality of obligation" (which is decreasing in importance as a factor in many working situations); or
- simply a desire for the arrangement to be outside IR35.
The size of possible liabilities has been an area of serious concern for investors in some of the M&A deals on which we have advised recently. It remains to be seen whether insurance-backed IR35 checking arrangements, heavily relied on by many, will be regarded as reliable by investors given the risks associated with this approach (which we have highlighted previously).
Holiday pay rights for temps
The Supreme Court is due to decide in 2022 whether businesses must revisit holiday-pay calculations for staff who don't work a whole year and where there is use of 12.07% rolling up mechanisms. This may lead to many umbrellas and staffing companies having unexpected retrospective holiday pay liabilities and complicated calculations for future holiday-pay arrangements. There may be union-backed class actions in 2022.
At the moment, there is no enforcement body that can bring these claims on behalf of workers in the way that HMRC can under the National Minimum Wage (NMW) legislation. It will be interesting to see if a new "workers watchdog" body (see below) is given enforcement powers relating to holiday pay or, for example, sick pay for temps.
Post-Covid cross-border working arrangements
Formal and informal cross-border consultancy arrangements with people who have relocated to (usually warmer) countries before and during the Covid-19 pandemic have come up a lot in recent deals. Tax authorities are aware of this trend and looking at the tax status of workers doing this and the liabilities of "employers" for workplace tax, corporation tax and VAT relating to their new overseas operations.
EU proposed legislation on contingent workers employment status – rebuttable presumption of employment status
The EU issued a draft directive in December 2021,under which organisations that use technology to arrange work for self-employed workers (which means gig-worker platforms and, probably, most staffing businesses) will be required to prove via a new five-step test that workers are self-employed. If they can't prove this then the worker will be deemed employed. This will, when it comes into force, affect gig-economy staffing platforms such as driver apps as well as UK and US staffing companies operating in Europe and using independent contractor models.
If there were a change of government in the UK, we would not be surprised to see similar measures being introduced in the UK. There are already similar regimes in other parts of the world, with increasingly tough tests in, for example, the US state of California and Spain.
New workers' watchdog
The Department of Business, Energy and Industrial Strategy has announced, in its latest consultation response, a "new workers' watchdog" which will provide a "one-stop shop" approach to tackle modern slavery, enforce minimum wage rates and protect agency workers (a responsibility that is currently spread across three different bodies) as well as delivering "a significantly expanded remit".
The new body will also have greater flexibility in the sanctions that can be issued to tackle the spectrum of non-compliance with an expansion to the reach of compliance notices and civil penalties. We can expect much more intervention given that the likely head of the body, Margaret Beels, is the former chair of the Gangmasters and Labour Abuse Authority, which regularly uses its enforcement powers to close down non-compliant activities.
The new body will continue the existing naming and shaming scheme, which has had an important deterrent effect, and this enforcement activity will also be extended to cover other regulations protecting the pay of workers (including those employed through agencies). It will also enhance workers' rights by providing a "single, recognisable port of call for workers so they know their rights and can blow the whistle on bad behaviour".
National Minimum Wage
We would expect the new workers' watchdog body to be particularly active in enforcing the NMW with investigations into flexible labour supply chains that relate to travel time, training time, prep time, uniforms and, possibly, liability for entities higher up the supply chain that have turned a knowing blind eye to breaches by suppliers. HMRC is already active in this area and so investors' advisers are carrying out detailed NMW enquiries in due diligence exercises. The way that NMW works makes it sometimes very difficult, if errors in calculation are discovered during due diligence, to rectify the problem or obtain warranty and indemnity insurance to give investors the confidence to proceed.
What do you need to do?
We will be issuing updates about these developments.
In the meantime, for those companies approaching an investment event, we recommend a pre-sale "tidy up" that looks at what is likely to come up as due diligence and deal-breaker issues. Taking early action is far easier than under the pressure of a deal deadline, by which time it is hard to negotiate and implement the necessary adjustments in the time available. We have developed systems and methodologies to make this process as efficient and cost-effective as possible.