Recent guidance makes clear HMRC expects end users and agencies to carry out due diligence on staffing suppliers

There has been a lot of publicity recently about staffing supply-chain risk. Some of these risks may be hard to control, such as a cyberattack on a payroll supplier which may leave contractors temporarily unpaid, but others, such as IR35 compliance or whether contractors are being paid via a tax avoidance or evasion scheme, will need to be investigated and avoided.

Growth in the use of contingent workers is now a feature of many workforces and looks set to continue with the increased use of gig workers and contractors. Wherever contractors are used, there will usually be a supply chain consisting of at least two or three parties – possibly more where a managed service provider agency is involved.

Additionally, end users are becoming more aware of issues and complexities in their staffing supply chain, particularly as recent reforms to IR35 have forced end users to take a closer look at their staffing supply chains. Many have been surprised to discover that the contractors that they assumed were engaged and paid by the agencies they deal with are, in fact, paid by an entirely different company, often an umbrella company.

Now that the lid has been lifted on staffing supply chains, end users and their supplier agencies can no longer afford to ignore the possible risks.

Due diligence expected

HMRC published guidance this May making it clear that it expects end users and agencies to carry out due diligence on their staffing suppliers, and we know that it has started citing this guidance in recent investigations.

Staffing companies that use umbrella companies have long had to face certain risks (such as tax debt transfer of an umbrella company's unpaid liabilities or being liable to pay out twice where an umbrella company folds and leaves contractors unpaid). The difference we are now seeing is an increase in HMRC's targeting of users of contract workers that allow or turn a blind eye to tax evasion in their supply chains.

HMRC is starting to flex its muscles to target companies using the Criminal Finances Act (CFA) and using its powers to penalise companies who are not undertaking sufficient due diligence in their supply chain. Just last month, HMRC publicly detailed that they were investigating 153 enablers of tax evasion and sent compliance letters to the financial services and oil and gas sectors to check end-user compliance with IR35.

It's not just about tax

While increased end-user scrutiny of supplier agencies and their supply chains may have been prompted by recent tax changes, supply-chain risk is not just about tax. The complexities of National Minimum Wage (NMW) compliance is an increasing area of concern for investors and clients given the heightened HMRC activity.

With the increasing challenges of finding workers to fulfil jobs, there are also increased risks of modern slavery creeping into the supply chain (which the Financial Times recently identified). Additionally, investors focussing on environmental social and corporate governance issues will want reassurance about compliance in this area. (If you are interested in hearing more about this, please register for our compliance session on human rights due diligence in supply chains on 2 November 2021.)

Increased awareness by end users of their responsibilities to seek compliance from staffing suppliers has started to drive a demand for stronger and wider indemnities. End users are also increasingly refusing to work with staffing companies that cannot demonstrate compliance within their own supply chain.

The raised awareness of these risks means that investors and end-user clients are focussing more and more on payment and tax arrangements in their supply chains. Workplace tax and other risks (such as NMW, holiday pay and international compliance) have also become key due diligence issues in most of the merger and acquisition and private equity investments in the workforce solutions sector this year. (We explored these themes in a recent webinar on de-risking staffing supply chains; if you are interested in further details, you can request a recording.)

Osborne Clarke comment

It is critical to ensure due diligence checks on suppliers, such as umbrella companies, and CFA compliance processes are up to date. While some may have previously implemented CFA compliance processes, legislation (and ways of avoiding or evading it) has moved on in the last few years, so any checks or CFA defences put in place two to three years ago are likely to need a refresh. These processes are also likely to be scrutinised by investors and, increasingly, by major clients who will expect to see strong compliance procedures in place and that there are no tax avoidance/evasion schemes lurking in supply chains.

CFA checks and related training should be reviewed, particularly in any organisation that has grown or acquired new businesses and staff. (By way of an update, watch this podcast by our tax litigation partner, Ian Hyde, detailing the importance of ensuring that CFA compliance processes are up to date.)