Engaging contractors through an agency – what are the legal issues when the contractor uses a limited company?

Temporary staffing solutions in the UK are becoming increasingly important to help businesses recover from the effects of the Covid-19 pandemic.  It’s been widely reported that businesses are looking to more flexible staffing solutions and one key area is the contractor market. 

Whilst some businesses will choose to engage contractors directly, many businesses will prefer to engage contractors through a supplier, such as a recruitment agency.  This article looks at the key points businesses should consider when seeking to engage contractors through an agency, the terms that should be contained in the commercial agreement and common areas of negotiation.  

Limited company contractors

Whilst there are many different staffing options for freelancers, consultants and agency workers, this article is focussed on contractors who choose to provide services through their own limited company (often referred to as personal services companies or PSCs).  For the purposes of this article we will refer to these individuals as ‘contractors’ although in some sectors different terminology may be used.

The impact of the IR35 reforms

One of the most significant changes to the way businesses engage contractors has resulted from the reforms to IR35 rules which come into effect for the private sector from April 2021. 

When engaging contractors through personal services companies, large and medium-sized businesses will be required to determine the tax status of contractors and, if appropriate, instruct the agency supplying the contractor to operate PAYE and make national insurance contributions. 

The commercial agreement between the business and agency should therefore include specific IR35 clauses setting out:

• The obligations on each party to ensure compliance with IR35;

• The steps to be taken if IR35 applies or doesn’t apply;

• Any changes to charges to account for employers’ national insurance contributions and the apprenticeship levy if IR35 applies; and

• The process by which determinations on status may be challenged.

Many businesses will also seek indemnities from the agency to protect them from any losses incurred if the agency fails to adhere to its duties under IR35.  This is a common area of negotiation, particularly as we are yet to see how HMRC will approach enforcement in practice, when the new rules come into effect.

Opting out of the Conduct Regulations

All recruitment agencies are subject to a statutory compliance regime which is primarily set out in the Conduct of Employment Agencies and Employment Businesses Regulations 2003 (Conduct Regulations).  These regulations are designed to protect both individuals seeking work (known as work-seekers) as well as the businesses seeking to engage them (known as hirers).  For further information please see our Inbrief on Staffing solutions and the supply of labour.

Unlike agency workers, most limited company contractors, unless working in certain sectors such as care, medicine or education, can ‘opt out’ of the Conduct Regulations.  This means that they can choose not to be protected by the legislation, often in an effort to support their tax status as self-employed.  The effect of the opt out, however, is that the hirer will also not be protected.  In these circumstances, it may be all the more important for businesses to include minimum compliance standards in the commercial agreement with the supplying agency.

In addition, businesses should consider contractual terms covering:

• The process the agency will follow if the contractor wishes to opt out; and

• Whether any commercial terms such as charges or fees will be affected by the contractor’s status.

Insurance

In addition to contractual terms covering minimum levels of insurance that the agency will have, agreements for the supply of contractors commonly set out the minimum insurance that the limited companies through which the contractor provides services must hold.  The common types of insurance which may be relevant are:

• Professional Indemnity Insurance;

• Public Liability Insurance; and

• Employers’ Liability Insurance.

The level of protection required will depend on the type of work that the contractor will be doing and the potential impact on the business if it goes wrong.

Businesses may also wish to consider including provisions in the agreement with the supplying agency that, if errors are made, the contractor is required to rectify them, in their own time and at their own cost.  However, businesses should be prepared for some push back from agencies and ready to negotiate on the precise drafting.

Due diligence

Aside from the practicalities of IR35, another reason businesses often prefer to contract with agencies for the supply of contractors, rather than directly, is that the agency will conduct certain suitability checks to ensure the individual can do the work.  The level of check required will vary depending on the type of work the contractor will be doing.  In addition, many businesses will require agencies, as part of the commercial agreement, to do further checks on the contractor’s limited company to verify:

• the limited company is registered at Companies House, is not in liquidation and is not subject to strike off from the register;

• the limited company is tax resident in the UK;

• the contractor is an employee or director of the limited company; and

• the limited company is not operating as a managed service company under Chapter 9, Part 2 of the Income Tax (Earnings and Pensions) Act 2003.

All these checks are designed to reduce the potential risk of claims from HMRC or the contractor. 

Conclusion

Before engaging contractors through suppliers such as recruitment agencies, businesses should check to ensure that the commercial agreement is fit for purpose and up to date before the changes to IR35 come into effect. 

Standard agreements for the supply of services are unlikely to be suitable as the supply of labour is subject to a different regulatory regime.  In addition, the specific topics covered above will be relevant for limited company contractors, but not other types of temporary staff such as agency workers.

For specific advice about agreements for the supply of contractors please contact the authors, or your usual Lewis Silkin contact.