Employment businesses will have noted Reed Employment’s tribunal case on VAT, but what does their other decision, in the income tax tribunal, mean for umbrella employers?
Reed Employment and a number of its group companies have just lost a major case involving umbrella workers who were being paid home-to-work travel allowances tax-free in substitution for part of what would otherwise have been their taxable wages. With £158m-plus at stake, the case is certain to be subject to further appeals, but what lessons can be learned at this early stage?
Reed employed all its temps (except for those where a VAT saving meant that contracts for services made more sense) and paid them a mixture of taxable pay and tax-free and NIC-free travel expenses. It was the exemption for the expenses that HMRC challenged.
A number of key questions were asked by the tribunal:
- Was the salary sacrifice they used effective?
- Were the travel allowances earnings or expenses
- Were there ‘temporary workplaces’
- Could HMRC lawfully have granted the dispensations?
- Did the dispensations cover the allowances?
- Should the PAYE and NIC treatment be the same?
The only point with an easy answer was the last: the regulations are different in their wording, but the effect is essentially so similar that there was no practical difference.
The most problematic issue seems to have been the temporary workplace rule, as Reed’s contracts were held to be ineffective in creating an ‘overarching’ permanent contract under which the temps were sent to a series of temporary workplaces. Because they were found not to have the mutual obligations typical of an employer-employee relationship between assignments, the workers were more like agency workers, who ordinarily have a series of separate permanent workplaces under a series of separate temporary employments. The workers were not under typical agency contracts ‘for services’, but neither were they under unbroken contracts ‘of service’, which are an absolute prerequisite if you want to exploit the tax rules for expenses to travel between home and work. They didn’t have a temporary workplace, so they couldn’t be paid any tax-free expenses.
The lesson for umbrella employment businesses is that the contracts under which temps are engaged must ensure that there are no gaps in the period when the normal employment relationship is not fully in force. Engineering a break between assignments or from time to time might prevent the accrual of certain employment rights, but it could fatally undermine any tax-free travel expense arrangements. HMRC has operated a rule of thumb that accepts that an overarching or umbrella contract exists if the employer guarantees 336 hours of work per year (equivalent to one 7-hour shift per week for 48 weeks), but this has no basis in tax law and is not truly reliable.
The tribunal started its decision by focusing on the salary sacrifice arrangements, but this seems odd. If the employees signed up to a contract that gave them an entitlement to a mixture of pay and expenses, that is arguably an end to the matter. To claim that a salary sacrifice was ineffective, as HMRC did, seems to miss a fundamental point about the nature of the contract, and presupposes that there was another contract that was changed, which does not seem to have been the case at all. The appeal will doubtless address this question, where the tribunal seems to have missed the point, but umbrellas need to watch how they rearrange their travel payments to avoid having the argument.
Reed also seems to have a legitimate grievance about the group’s treatment by HMRC. The dispensations that made the travel expenses tax- and NIC-free were seen and agreed by HMRC no less than five times over the years, so the group can arguably feel justifiably aggrieved that HMRC did not raise their objections at the outset, choosing instead to withdraw the agreements retrospectively. Employment businesses can only counter this type of treatment by ensuring that absolutely everything (and more) is disclosed to HMRC in any negotiations over future dispensations.
There is potentially a whole industry riding on the outcome of the forthcoming appeals. Steps taken now can avoid problems in future, but we need a crystal ball to work out where this is going.