City contractors could see decline in demand through VAT budget provision

Contractors who work for banks, insurance companies, charities, some health care organisations, education organisations, or in the sports or betting sectors could all see a decline in demand due to a change in the VAT concessions provision in the first Darling Budget.

Change in Cost Structure

The Chancellor announced at the Budget that the 'VAT staff hire concession' will be withdrawn from April 2009. The concession allows staffing companies supplying the services of agency workers to zero rated businesses to charge VAT only on their margin or commission. This can represent a significant cost saving for businesses which cannot recover or fully recover VAT.

''This is a complex area, but overall we believe that this change will lead to an increase in the cost of engaging temporary workers and contractors in certain sectors such as banking and may lead to a reduction in the demand for such workers if the measure passes into law in its current form,'' says Frances Lewis, a lawyer with the London-based firm Blake Lapthorn Tarlo Lyons.

The London-based British Banking Association agrees saying that a decline in contractor demand would result from the measure.

Cannot Charge VAT

The problem for banks, for example, is that they cannot charge VAT on retail services. This would oblige them to pay considerable amounts of VAT on contractors ' services which they could not necessarily recuperate, Lewis explains. The abolition of the VAT staff hire concession would net the Treasury an extra 150 million pounds in2009/10 and 120 million pounds in 2010/11, the Treasury claims. At the same time, one charity has estimated that the measure will add 300,000 pounds on to its costs for agency workers.

A spokesperson for the British Banking Association comments: ''We regret HMRC’s decision to withdraw the staff hire concession at this time. The concession facilitates the employment of temporary staff which contributes to the flexibility of the British economy in general and to that of the City of London in particular. At a time when city is facing both the threat of a recession and an increase in foreign contribution competition, this will make it less competitive, thereby reducing jobs and government revenue.''

More than 100,000 contractors work in the financial services sector in the City. It is possible that demand for their services will be affected, albeit on a small scale, if this measure is passed.

Says Ann Swain, chief executive of the London-based Association of Technology Staffing Companies: ''If organisations have to pay VAT on temps' pay and not just the recruiters' margin, the cost to UK plc of using temps is going to rise significantly."

"The Government is forever praising the contribution temporary workers make to UK competitiveness, but if VAT is charged on fees, organisations may use fewer temps, and the flexibility of the UK labour market will be compromised. We've heard Gordon Brown insisting that the UK needs a flexible workforce, but we've had nothing but one attack after another on our industry which provides that workforce.''

A Problem From Case Law

Lewis points, however, to a case law issue that could affect the entire question, regardless of Darling's budget plans.

The High Court decision in the Reed case (Customs and Excise Commissioners -v- Reed Personnel Services Limited) can be interpreted as establishing that: where the end user's only contractual relationship is with the staffing company there is no direct contractual relationship between the temporary worker and the end user, the services provided by the temporary worker and those provided by the staffing company could, for VAT purposes, still be treated as if there was a direct relationship between the end user and the temp.

In other words, so far as payments received by the worker are concerned, the staffing company is deemed merely to be acting as the end user's agent for VAT purposes. This slightly surprising case means that VAT is chargeable on the margin charged by the staffing company but the rest of the charge has a different VAT status ( i.e. VAT is generally not chargeable in respect of the element of the staffing company's charge which is paid on to the worker).

HMRC has been asked to comment on this case law, and a response is expected at the beginning of April.