Does the decision in Reed provide an opportunity for charities to receive a refund of VAT on the cost of temporary workers?

Introduction

Typically, but dependent upon the arrangements between the Charity, the temporary worker and the employment agency, VAT (at 20%) is due on all charges made by the agency in respect of the temporary worker (including the pay costs and national insurance contributions). For most Charities (which are unable to reclaim all of the VAT they incur) this creates a direct and often significant cost. However the recent decision of the first tier tribunal in Reed Employment Limited v HM Revenue & Customs (LON/2004/0130) brings the current VAT treatment into question. Is there now an opportunity for affected Charities to gain a refund of VAT overcharged, and if so, what action should Charities take?

Background – The VAT Treatment

Following the introduction of the Conduct Regulations,[1] employment agencies usually engage temporary workers in a ‘contract of services’ in which the employment agency is normally required to operate PAYE on behalf of the individual. Typically, under the employment agency’s arrangements with the charity, the temporary workers are assigned to the charity and work under its control. In these types of arrangements, an employment agency’s charge to a charity includes the temporary worker’s hourly gross pay rate (including national insurance contributions) as well as the employment agency’s commission for the introductory and ancillary services it provides (such as the processing of wage payments and the withholding of national insurance contributions).

Where the employment agency is involved in managing the payment of temporary workers directly or indirectly, it is generally accepted that, for VAT purposes, the bureau is making a supply of that temporary worker to its client (i.e. it acts as a principal). Where this is the case, there is an expectation that VAT at the standard rate (currently 20%) will be charged on the total amount paid by the client for the temporary worker, including the individual’s salary and related costs.

Whether the VAT charged to the client is recoverable normally depends upon the activities that the temporary worker will carry out for the client. The general rule is that provided the temporary worker is engaged in an activity which generates income which is wholly subject to VAT, the VAT charged is fully recoverable by the client. However, for most Charities this is not the case, meaning that at best the VAT charged is recoverable in part (in accordance with the VAT recovery methodology undertaken by the Charity) or at worst, wholly irrecoverable, i.e. because the temporary worker is engaged in undertaking an exempt or non-business activity of the Charity. This latter scenario is most likely for Charities involved in the health and welfare sector, which typically engage temporary workers (which may not qualify for the concession outlined below) to perform front line services, creating a direct and often significant additional VAT cost.

It wasn’t always this way! Indeed, prior to 1 April 2009, it was generally possible to avoid a VAT charge on the salary and related costs of the individual. This was possible either because the employment agency was acting as an agent rather than a principal in supplying the temporary worker as the conduct regulations were not yet in place or because (for employment businesses) the staff hire concession was applied. This concession was however withdrawn with effect from 1 April 2009.  

Of course there are still situations where VAT is not chargeable on the charges made by the employment agency in whole or part and these are detailed below.

[1] Conduct of Employment Agencies and Employment Businesses Regulations 2004 (SI 2003/3319 as amended).

When might VAT not be chargeable?

Whilst the general position as outlined above is that VAT is chargeable on the whole of the amount charged by the employment agency to its client, there are some exceptions. Thus, it remains the case that where the employment agency is acting as an agent in supplying the temporary worker, VAT is only due on the amount equivalent to the commission element charged by the employment agency  (the pay and associated costs remain VAT “free”). However, HMRC’s general view appears to be that, since the conduct regulations mean that employment agencies are prohibited from paying workers directly or indirectly, there is an expectation that those that do so are not acting as agents but as principals.  

In addition, provided certain conditions are met it is possible to treat the supply of nursing staff and nursing auxiliaries supplied by employment agencies, as principal, as being exempt from VAT. Thus, VAT is not due on any charge made by the affected agency in respect of these qualifying individuals.

However, for other staff provided in the circumstances previously outlined, HMRC’s view has been that usually VAT is due on all charges levied by the agencies. The Reed Employment Limited case has challenged that view.

Reed Employment Limited v HM Revenue & Customs (LON/2004/0130)

Reed Employment Limited (“Reed”) provided temporary workers which were engaged by it either as employees or through contracts for services. In common with other employment agencies, Reed was involved in the payment of the temporary workers’ salary and charged its client accordingly, in addition to further charges equivalent to the workers’ national insurance contributions and Reed’s commission for its introductory and ancillary services.

HMRC argued that the legal and contractual framework under which Reed operated should determine the VAT treatment of the services. Accordingly, HMRC were of the view that since the temporary workers were engaged by Reed under contracts for services, Reed should be seen as supplying its staff to its clients (i.e. acting as principal) and therefore VAT was due on the full amount charged to its client.  

The Tribunal disagreed, and finding for Reed, concluded that Reed was acting as an intermediary and therefore, VAT was only due on Reed’s services to its client (i.e. its introductory fee/commission). In reaching this conclusion, the Tribunal viewed the payment of the amount equivalent to the pay rate of the individual as being a payment by Reed on behalf of its client, for which it was subsequently being reimbursed, rather than as a payment for a supply by it. In other words, Reed’s only supply for VAT purposes was the introduction of staff (as well as various ancillary services) in return for a commission.

The key reasons for the Tribunal’s decision can be summarised as follows:

• the legal/regulatory framework and contractual relationships under which Reed, its clients, and the temporary workers operated were not on their own determinative of the VAT treatment of the supply;
• there was no mutuality of obligation between Reed and the worker- Reed was not obliged to offer assignments to the temporary workers and they were not obliged to accept them;
• Reed never exercised control over the temporary workers so was not able to pass this control to the client; and
• the overriding consideration when determining the nature of a supply for VAT purposes and by whom and to whom it is made is the economic reality of the arrangements in place.

Viewed in this way, the Tribunal found that Reed was supplying an introductory service to its clients, rather than making a supply of staff in its own right.

It should also be noted that Reed appealed against HMRC’s decision not to pay a number of retrospective claims submitted by it for VAT overpaid on amount equivalent to the pay and related costs of temporary workers, arguing that it should have only accounted for VAT on its commission/introductory fee. Although some of these claims were paid by HMRC, Reed was unsuccessful in the arguments put to the Tribunal in respect of those that were not.

What does this mean for Charities?

Whilst the decision in Reed is welcomed and could help reduce the irrecoverable VAT costs for Charities, it is possible that the case will be appealed. Thus, uncertainty over the treatment could remain for some time, until the litigation process is concluded.

There are also likely to be further questions which need to be answered, such as:

• if the decision in Reed is upheld, will well paid individual temporary workers need to register and charge VAT where the pay costs exceed the VAT registration limit?;
• how will the situation be affected where individuals operate via a personal service company?; and
• will those employment agencies which employ temporary workers be affected by the decision in Reed?

However, if  the decision in Reed is upheld, those employment agencies affected and who have applied the same VAT treatment as Reed, will have charged VAT on pay and related costs of the temporary worker in error. As a result, under the normal process, it will be necessary for the employment agency to submit a claim for VAT overpaid to HMRC, whilst making arrangements for any VAT charged erroneously to its clients to be refunded (resulting in a refund for affected Charities).

Progress in the litigation process should therefore be carefully monitored against the time limits (usually four years) for submission of any claim by employment agencies for VAT overpaid.

What action should Charities take?

Although the decision in Reed may be tested further, Charities should review now the VAT treatment applied to charges by employment agencies in respect of temporary workers, over the last four years. Charities should consider now whether, under the current rules, VAT has been correctly charged (i.e. is the employment agent not responsible for paying the temporary workers, are the temporary workers nursing staff or auxiliaries and therefore can quality for exemption?).

In the event that VAT has been charged in line with the position pre-Reed, Charities should consider the impact of the Reed decision and be discussing with their employment agency suppliers submissions of claims for VAT overpaid to protect against the expiry of time limits. Charities should also consider amending the current arrangements with a view to making them more VAT efficient where possible.