The Staff Hire Concession, which enables recruitment businesses to calculate and charge VAT on their profit margin rather than on the total value of their invoice, including labour costs, was withdrawn with effect from 5th April 2009. The effect of this change in the tax treatment of temporary labour invoices is to increase the tax burden on customers who cannot recover input VAT in full. Recruiters normally only operated the Concession on invoices to customers in the relevant industries: financial services, health, charity and parts of the public sectors.

Properly implemented, there should be no disadvantage for financiers from this change. Indeed, for financiers charging service fees on the value of gross assignments, there will be more income as a result of the increased invoice values. However, there are a number of legal and practical risks that could affect their security. This briefing looks at how financiers can assess if such risks are present in their recruitment clients’ sales ledgers.

The Staff Hire Concession was an acknowledgement by HMRC that temporary workers should not be disadvantaged in the labour market by having VAT charged on their wages because they worked through an agency when employees’ wages are outside the scope of this tax. In consequence, the Concession only applied in respect of wages paid to PAYE temps so financiers need not be concerned about recruitment clients that only supplied “contractors” operating through a company or LLP.

The table below shows that when a recruitment business operating the Staff Hire Concession switches to charging VAT on its full costs, the prepayment it will receive from a factor or discounter will increase substantially (by how much depends on the average profit margin – the lower the recruiter’s profit margin, the greater the proportionate increase in finance will be).

The transition from charging VAT on the profit margin to calculating it on the total cost creates several risks. The prime concern must be that the VAT-inflated value of the debts might not be contractually enforceable against the debtor. However, if the recruiter fails to change the way it manages its cash flow it could also create a serious liquidity problem that could lead to failure. Finally, if recruiter and customer have entered into a scheme designed to avoid the increased VAT burden the basis on which funding has been granted could be undermined by the changed contractual terms. These three possibilities are reviewed below.

Contractual risk

Contracts between recruiters and customers that cannot recover input VAT in full have historically specified that Value Added Tax will be charged only on the profit margin. Unless such a provision has been renegotiated (or the contract envisaged the eventual withdrawal of the Concession and specified that the customer could then be charged VAT in full), invoices correctly calculated in accordance with UK tax law from 6^th April could legitimately be underpaid by those customers who choose to enforce their contractual rights. In the example given in the table above, the debtor would only pay £10,165 which is less than the prepayment made to the recruiter of £10,350. This risk is heightened, of course, if there is no ongoing relationship between recruiter and customer when the invoices are due for settlement.

Cash flow risk

Recruiters’ cash flow planning models are often maintained on spreadsheets that reflect a historic average rate of output VAT. Unless the model is amended to reflect the new circumstances, recruiters may inadvertently spend the extra cash received from factors and discounters representing the prepayment against the much-increased VAT element of the invoice. This raises the risk of the recruiter not being able to meet the substantially larger VAT liability due when the first VAT period following by the Concession’s withdrawal comes to an end.

Compliance risks

A number of schemes have been marketed to recruiters and their customers to circumvent the requirement to charge VAT on the labour element of invoices. Generally these involve changing the contractual obligations between the parties (worker, agency and customer). For a financier this raises the concern that the contractual basis of the receivables that was reviewed at the time the decision was made to finance invoices to the customer in question may have altered fundamentally. It is advisable to reappraise the contractual terms between recruiter and customer if a “VAT-friendly” solution has been implemented and adjust funding levels if appropriate.

Checklist for factors and discounters

1. Do we finance invoices raised by recruiters currently operating the Staff Hire Concession?

2. Do any of the customers invoiced on this basis represent a significant percentage of the recruiter’s ledger?

3. Of the customers in 2 above, which ones have contracts that oblige the recruiter to limit the calculation of VAT to its profit margin?

4. Have the recruiters in 3 above renegotiated this clause of their contract, and have we obtained a copy of the variation agreement?

5. If not, what reserve or adjustment to our advance rate should we make?

6. Have our affected recruitment clients adjusted their cash flow modelling to take account of any change we make to our reserve or prepayment rate and the greater VAT liability due at each VAT period end?

7. If any recruitment clients have implemented new contracts with major customers as a result of their wish to avoid the extra VAT burden have we examined them to assess any potential consequences for our collateral?

Other lenders offering facilities to recruiters should consider a similar evaluation of potential risks.

Contributed by:

Hugh Fell MA, MICM                                                                                                                                                             Hugh Fell & Associates                                                                                                                                             Mobile:     +44 (0) 7833 457423                                                                                                                                 Email:        hugh.fell@hughfell.com

Hugh Fell is the principal of Hugh Fell & Associates, a specialist provider of consultancy services to asset based lenders worldwide and recruitment businesses in the United Kingdom.  Hugh has worked for 27 years in the ABL industry, most recently as Head of Recruitment Finance at Lloyds TSB Commercial Finance Ltd. Hugh has unrivalled expertise in, and experience of, financial risk management in the recruitment sector as well as an in-depth understanding of factoring / invoice discounting systems and processes