Introduction
What are PEOs?
When might businesses use PEOs?
Legal issues
Common commercial terms and considerations
Comment


Introduction

All companies, wherever they are based in the world, want to staff their businesses in a workable way. Growing numbers, particularly in the United Kingdom, are turning to the Professional Employer Organisation (PEO) model, which involves engaging the services of a third-party organisation with responsibility for employing and paying staff and dealing with tax, social security and other such matters.

Businesses do not, however, always realise the legal ramifications of going down this route. This article looks at different types of reasons for using a PEO, the legal considerations and the potential pitfalls.

What are PEOs?

A PEO is a third-party organisation contracted to take responsibility for employing and paying employees. This includes dealing with employment contracts, payroll, taxes, visas and sponsorship, benefits and insurances. The PEO employs the individual and supplies them to the end-user company, charging a fee for this service. The end-user retains the ability to direct and supervise the individual on the ground.

There is an employment contract between the PEO and the employee and a commercial contract between the PEO and the end-user, but no direct contractual relationship between the employee and the end-user.

When might businesses use PEOs?

PEOs can be useful when looking to engage individuals abroad. Cutting-edge technology has enabled companies to expand internationally and access new customer and talent bases. The ongoing covid-19 pandemic has also prompted both employers and employees to try new ways of working and consider different locations for doing so (for further information please see "Working from home abroad: considerations for employers"). As a result, more businesses are looking to use staff outside of the countries in which they currently operate.

There are a few ways this can be set up. One option is for the company directly to hire an employee based in a different country to it. This is fine from a UK perspective, but local laws may prohibit it in some locations. Another option is to establish a new company abroad to employ the person, but that is not always convenient or desirable. Local corporate, employment and tax laws can be complex and there are obviously costs involved. The situation may become even more complicated where the employee works in different countries. The PEO model can take care of such onerous obligations, for a fee, which is why growing numbers of companies are using them to expand abroad.

In the United Kingdom, an increasingly widespread reason for choosing a PEO is to avoid IR35 obligations.(1) Where a contractor provides their labour through a personal services company (PSC), large and medium-size end-user businesses must carry out a status determination to determine whether, ignoring the existence of the PSC, the contractor would be an employee of the end-user. If the answer is "yes", the business needs to account for tax, social security and apprenticeship levy on the fees paid to the PSC. A PEO provides an alternative model in which it (rather than the PSC) employs the individual and supplies them to the end-user – thereby avoiding the application of IR35 and ensuing hassle altogether.

PEOs are also often used to keep down headcount - a common issue among business heads who would like to hire staff but face internal difficulties in doing so.

Legal issues

While there is no doubt that PEOs can be extremely convenient, not everyone realises that depending on the services a PEO provides it may fall within the United Kingdom's legal regime governing the supply of labour.

A PEO is likely to be subject to the Conduct of Employment Agencies and Employment Businesses Regulations 2003 (the Conduct Regulations). This is the same regime that governs what is widely known as a "temping agency", although a PEO may not look or feel like one of those.

The Conduct Regulations are strict and designed to protect both the individual and the end-user. For example, the PEO would need to provide a "key information document" to any work-seekers and be transparent about any transfer fees in the commercial agreement with the end-user.(2)

In some cases, a PEO may also be subject to the Agency Worker Regulations 2010 (AWR), which derive from EU law. The AWR apply where an individual (other than a genuinely self-employed contractor) is supplied for an assignment by a temporary work agency to work temporarily for and under the supervision and direction of an end user.(3)

PEOs may be used as a temporary means to an end, such as while a business finds its feet in a new jurisdiction or because of a lack of headcount budget at the point of hiring. In such situations, the AWR would be likely to apply. Alternatively, PEOs are sometimes used for indefinite engagements, as though the end-user has hired its own permanent employee, in which case the AWR may be less likely to apply if the engagement is genuinely not time-limited in practice.

Under the AWR, from day one of the assignment, the end-user must provide the individuals being supplied with the same access to collective facilities and amenities as it does to its own comparable, directly hired staff. This is a direct obligation on any end-user company, for which it is solely liable. That means that any individual, despite being employed by the PEO, could seek to bring a claim against the company directly for its failure in this respect.

After 12 weeks in the same assignment, a supplied individual receives the right to the same basic working and employment conditions as a person hired directly by the end-user company would receive. The PEO will still pay the individual, but any failure to pay the correct amount could be a joint and several liability between the PEO and the company (depending on whose failure has led to the incorrect pay).

Similar rules apply in other European jurisdictions, where supply of labour is commonly described as "employee leasing", and in some countries there are limits on which industries and sectors can engage with PEOs.

End-user companies should be careful that they are contracting which a PEO which provides them with what they need. Some organisations offer an "Agent of Record" model, under which they supply individuals as contractors and handle payments on their behalf. This would not be a suitable model for an end-user looking for a third party to employ individuals and carry the liabilities of employer.

Aside from labour supply issues, end-user companies should consider how they will protect their business once an individual's employment has been terminated. Restrictions need to be drafted to accommodate the reality that, while the end-user is not the employer, it is nonetheless the one that stands to lose if not adequately protected. There is no "one size fits all" for such restrictions, which must be considered on a jurisdiction-by-jurisdiction basis and meet local law requirements. In some European countries, for instance, the individual must receive a compensation payment for the duration of any restriction for it to be enforceable. In other countries, restrictions may simply be prohibited.

Common commercial terms and considerations

In light of the UK statutory compliance regime regarding supply of labour (and in other countries too), it is good practice for end-user companies and PEOs to ensure that the associated legal risks are addressed and apportioned sensibly within the commercial terms.

We would expect to see the following types of clauses in the commercial agreement between a PEO and end-user company (depending on duration for which the individual(s) will be employed and the relevant jurisdiction):

  • Responsibility on the PEO for carrying out suitability checks on the individual worker. This can extend to verifying professional qualifications and confirming whether the individual is subject to any restrictive covenants.
  • The provisions that apply if the end-user company considers the individual worker is no longer suitable.
  • Responsibility and protection for the end-user company in terms of confidential information and intellectual property.
  • What transfer fees may apply if the end-user company seeks to engage the individual directly.
  • Requirements around the provision of information between the parties regarding the assignment and the individual. The PEO will want to ensure that the company provides it with the necessary information to allow it to pay people correctly after 12 weeks, where the AWR may apply. It will also want to specify that the cost to it of meeting the requirements under the AWR are passed on to the end user.
  • The various agreed fees for the PEO's services, such as: the general services fee; social security charges which the PEO will need to account for; tax-filing fees; payments specific to the local jurisdiction such as prescribed termination payments or a 13th month payment; and business travel insurance for mobile employees.
  • Provision of the necessary certifications by the PEO, particularly in relation to social security and taxes.
  • Obligation on the PEO to comply with all local licensing requirements relating to its activities or provide proof that it holds the relevant licences.
  • Obligation on PEO to comply with all local employment law requirements when employing the staff being supplied.
  • An indemnity from the PEO in respect of any employment claims an individual may attempt to make against the end-user company.
  • A clause requiring that the contractual documentation between the parties should specify that the individual's employment will remain with the PEO throughout and not the end-user company. The documentation also needs to be clear that the relationship will not at any point resemble one of co-employment or joint employment between the PEO and end-user company.

Regarding the final two points above, end-user companies should remember that in practical terms an indemnity is only as good as the party giving it. Accordingly, they need to make sure they are comfortable that, were an indemnity to bite, the PEO would be able to honour its obligations under it.

It is not uncommon for the activities of a PEO to be presented as the supply of services, rather than the supply of labour – whether inadvertently, or deliberately to limit the appearance of a supply of labour. A PEO's activities may in practical reality amount to both things.

For an end-user company, it may be possible to accept a commercial agreement for the supply of labour in the United Kingdom which is presented as a services agreement. However, it is generally advisable to be upfront about the arrangement and certainly advisable to seek indemnities relating to labour supply, the AWR and employment status.

In the United Kingdom, there are no limits on the length of time for which an end-user company can use a PEO. They can be used to engage an individual on an indefinite basis or on a short-term/project basis – whatever is needed. Moreover, PEOs do not need a licence to supply labour and provide a flexible staffing solution. (Note, however, that the position is markedly different in some other countries where the law is significantly more restrictive.)

Comment

PEOs can solve a lot of employment and tax/social security problems for those companies looking to expand outside of the United Kingdom or to avoid the burdens placed on them by the recent IR35 reforms. They should, however, be used in the full knowledge that labour supply legislation may apply. When the PEO will be providing a global service, special care should be taken to understand local law requirements, which can have significant consequences if breached.

For further information on this topic please contact Abi Frederick or Lee Nair at Lewis Silkin by telephone (+44 20 7074 8000‚Äč) or email ([email protected] or [email protected]). The Lewis Silkin website can be accessed at www.lewissilkin.com.

Endnotes

(1) Further information is available here.

(2) Further information is available here.

(3) Further information is available here.