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Q&A: NHS agency - healthy VAT saving or avoidance?

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With the current interest in perceived corporate tax avoidance, it seemed only a matter of time before an NHS scheme designed to avoid VAT on agency staff came into the media spotlight.

Given the values involved, HMRC is now investigating the situation, but it would be interesting to see what action will or can be taken to address the issue.

The medical agency VAT problem

Generally, the supply of medical care by doctors is exempt from VAT. The supply of a doctor by an employment agency (bureau) is, however, taxable; this is on the basis that the doctor comes under the direction and control of the end client, so there is a supply of staff rather than care.

In the past, agencies were allowed to use the VAT staff hire concession, which meant that they only charged VAT on their commission. This concession was withdrawn from April 2009, except for nursing agencies which can still choose to exempt their supplies.

The matter was considered further in 2011, when the First-tier Tribunal ruled in favour of Reed Employment (TC01069), suggesting that an employment agency should only charge VAT on its commission, i.e. for introductory services only, rather than the entire charge. The FTT concluded that for a taxable supply of staff to exist, there must be passing of control from the supplier to the recipient. Because the staff had no obligations to Reed until an assignment started and Reed had no ability to exercise direction or control, the FTT decided that Reed was making limited supplies, characterised as introductory services. Charges to cover wages, etc, were therefore VAT-free.

HMRC pointed out that the ruling related to pre-2003 periods, when different employment agency regulations applied. The FTT however based its decision on the ‘economic reality’, (i.e. the direction and control and staff obligation points) rather than the regulatory framework and contracts, suggesting that the ruling could apply to post-2003 supplies.

Interestingly, the VAT exemption also applies to ‘the provision of a deputising doctor’, to cover supplies of out-of-hours services for GPs, or other cover for sickness, holidays, etc. If a deputising doctor has ‘control’ over the work they do and how/when they work, this is arguably an exempt supply of healthcare services, even if from an agency. So, there are a couple of different arguments for not charging VAT that may be subject to future litigation, but in the meantime, HMRC’s stance is that supplies of doctors by agencies are subject to VAT.

How does this affect the NHS?

NHS trusts benefit from the VAT refund mechanism (VATA 1994 s 41), which allows them to deduct VAT on certain bought in services. This includes VAT on agency nurses but not other medical agency staff.

The withdrawal of the staff hire concession in 2009 resulted in a huge increase in medical agency VAT costs for the NHS. With trusts having to make the most of their budgets, some have been tempted by a scheme designed to circumvent this VAT.

What is the scheme?

In order to save agency VAT costs, trusts have been encouraged to use alternative arrangements which change the way employment agencies introduce short-term workers. Rather than supplying staff and charging VAT, the staff are introduced by the agencies on short-term employment contracts. The wages, tax and NIC are then dealt with by the trust as an employer. The agency only charges VAT on the introductory fee, levied for each shift worked. Promoters of the scheme manage the process, including new agency contracts and the use of online software. The changed contractual arrangements effectively put the VAT position back to what it was before the staff hire concession was withdrawn.

From a contractual perspective, the scheme appears to work. When HMRC withdrew the staff hire concession, it published Information Sheet 03/09 aimed at agencies which stated: ‘If you are not making a supply of staff as principal, but instead act as an intermediary in finding work for work-seekers, or workers for your client and:

  • those two parties enter into a direct contractual relationship with each other
  • you (or any person with whom you are connected) do not pay, or arrange to pay, the workers

then you are an agent. Your supply is not of staff but rather intermediary services of finding work-seekers/employment.’

As such, VAT is only due on the intermediary/introduction fee. HMRC also suggested that some agencies acting as principals may restructure to become agents and it is not their intention to prevent legitimate restructuring.

Is it avoidance?

HMRC also stated in Information Sheet 03/09 that ‘changes in form (contracts) must be matched by changes in substance in order to become an agent. HMRC may consider arrangements entered into in order to avoid the correct VAT consequences to be tax avoidance.’

HMRC is likely to investigate whether there is a mismatch between the form and substance of the current arrangements. Interestingly, this would contradict their response to the Reed decision, where they seemed to say the regulatory frameworks dictated the VAT treatment.

It therefore remains to be seen what approach HMRC will take now. The Department of Health has stated that procuring tax advice in the NHS was ‘acceptable where necessary for the fulfilment of statutory functions or to assist in compliance with rules beyond in-house expertise’, however, ‘entering into agreements where the primary aim is to avoid the payment of tax’ was unacceptable’. HM Treasury has also been similarly critical.

There is clearly an acceptable place for tax advice within the public sector; however, it remains to be seen whether these arrangements step over the line of acceptability.