VAT implications of outsourcing labour services

Research Article:

Author: Dan ZITUNGA; MBA, CPA                                      
Reviewer: Paul Frobisher MUGAMBWA; MBA, FCCA
                                    

1. Many enterprises choose to outsource some of their functions to an independent Labour Hiring Company (LHC), especially those functions which entail relatively low-skilled or unskilled workers, or simply because the enterprise wants an LHC to handle its payroll administration. This is common for functions such as call centre operations, construction site works, loading & offloading in a factory, and outdoor marketing campaigns. The main reason for outsourcing is to reduce the risks and costs associated with labour law, for example; hiring costs, employee retention costs, employee disciplinary actions, salary administration, dealing with tax and social security obligations, potential claims for unfair dismissal, and generally managing employees.
2. However, in most cases, the LHC is only a nominal employer, as the actual work is performed at the premises of the business that contracts the LHC (the consumer of labour), which also pays the salaries, supervises and controls the employees’ daily tasks. The LHC mainly handles the payroll administration, receives the money from the consumer of services, pays the employees, and remits the taxes to Rwanda Revenue Authority (RRA). The money received from the consumer of services is usually kept in a separate bank account that is not part of the LHC’s books of accounts.
3. The LHC may claim that it is the legal employer because it signs the employment contracts, manages the payroll, and handles any employee grievances and discipline. However, the reality is that the consumer of labour is the one who decides whether any disciplinary action is needed, as it is the one who has direct contact and control over the employees.
4. Another scenario is when a multinational company (MNC) with a subsidiary or branch in Rwanda sends some of its staff from another country to work in Rwanda on secondment, but they maintain their employment contracts with the original employer. The Rwanda subsidiary or branch pays the salary taxes (PAYE) to RRA, and then transfers the salary proceeds to the original employer, who then pays the staff.
5. In different countries, Tax Authorities have sometimes overlooked the Value Added Tax (VAT) aspects of outsourced labour services, as long as the payroll taxes (PAYE, social security) have been correctly calculated and paid as required. However, there is a growing trend of Tax Authorities and courts of law challenging this practice and requiring LHCs to charge VAT on the labour services they provide, not just on the management fee, but on the total invoice to the consumer of the labour services. This has implications for both the LHCs and its clients, as well as for the expatriate staff and their employers.

The provisions of Rwanda VAT law.

6. According to Article 3(1)(a) of Law N^o 049/2023 of 05/09/2023 establishing Value Added Tax, and the previous Law N 37/2012 of 9/12/2012, as amended, “Value Added Tax is charged on taxable goods and services, including online supplies”. Article 2 of the same Law defines “service” as “any intangible activity performed for one or more persons in return for payment”.
7. Article 11(1⁰) of Law N° 37/2012 as amended (now repealed), states that VAT is chargeable on the “consideration paid in money by the recipient” of the services. This is the money that the service provider (LHC) is entitled to receive for supplying staff to the consumer of the services.
8. Based on these legal provisions, it is clear that outsourced “management of payroll” or “labour supply” service, whichever term is used to describe the service, is subject to VAT because the following conditions are met:

• There is a contract to provide a service.
• The service is provided in return for a payment by the recipient of the service.

Matter of contention

9. The above legal provisions notwithstanding, there is practical evidence that some LHCs, and some subsidiaries hosting expatriates seconded by their parent or related companies in MNCs, have disagreed with tax administration authorities in different jurisdictions about the base on which to compute VAT.
10. To illustrate the VAT issue, let us assume LHC supplies 200 employees to company ABC, and ABC pays monthly salaries totalling RWF 30,000,000 to LHC for onward payment to the employees, and also pays a “payroll management fee” of 10% of the payroll amount (RWF 3,000,000) to LHC. LHC then pays the salaries to the employees (net of statutory deductions totalling RWF 8,100,000). LHC also pays the related statutory payroll taxes to RRA, as well as 18% VAT on RWF 3,000,000 (RWF 540,000).
11. In the above example, whether the “consideration” for the service rendered by LHC to ABC is RWF 33,000,000 or simply RWF 3,000,000 is matter on which there have been varying positions, particularly because VAT law definition of “consideration paid in money” is non-specific. Often, the argument would be that VAT is only due on the management fee (RWF 3,000,000).
12. In the following paragraphs, we look at how courts have ruled on similar cases in different jurisdictions.

CASE 1: CGI Group (Europe) Limited v HMRC [2010]

13. In this case, the appellant, CGI Group (Europe) Limited, appealed against a VAT assessment by Her Majesty’s Revenue & Customs (HMRC) [the equivalent of RRA in the United Kingdom (UK)].
14. CGI Group (Europe) Limited (“CGI”) was a LHC that outsourced the running of the IT department of Cox Services Limited (“Cox”), an insurance company. According to a “Master Services Agreement”, the employees were jointly employed by both Cox and CGI, and the payments to CGI by Cox included a portion payable to the employees as wages. As Cox was an insurance company, it could not recover the input VAT incurred on the outsourcing services, and CGI believed that the money received for paying the employees in wages should be excluded from the VAT calculation.
15. The main issue before the Tax Tribunal was whether VAT was chargeable on the proportion of the payments to CGI that was for onward payment to the employees as wages, given that the employees were “jointly employed”.

Decision of the Tribunal

16. The Tribunal found that the employees were legally jointly employed by CGI and Cox, but in reality, they were working for CGI, which supplied labour services to Cox. Therefore, VAT was due on the full amount received by CGI, including the portion for paying the employees in wages.
17. The full Tribunal judgment may be accessed on:

https://www.bailii.org/uk/cases/UKFTT/TC/2010/TC00678.html

CASE 2: ADECCO UK & OTHERS Vs HMRC [2018]

18. The facts of the case are that:

• ADECCO was an “employment agency”, hiring and supplying staff to its clients.
• Contracts of employment were signed between ADECCO and the individual staff, and no contract existed between the staff and ADECCO’s clients.
• The contracts of employment stated that the employee was “seconded to work for, and under the control of” the client.
• ADECCO paid the staff.
• ADECCO periodically invoiced its clients an amount that covered the salary it had to pay to the staff, related taxes, plus a commission (management fee) for the services.
• ADECCO paid the payroll taxes (PAYE) directly to HMRC.

19. HMRC assessed ADECCO for VAT on the entire invoice to the clients.
20. ADECCO objected to the assessment and took the matter to court, eventually reaching the Court of Appeal (Civil Division) of England & Wales.
21. ADECCO argued that VAT was not due on the full amount received from its clients, because most of it consisted of salaries payable to the staff, and that VAT was only due on the commission (management fee) received for providing the service of supplying staff to the clients.

Decision of Court

22. The Court considered the question: “What is it, for VAT purposes, that ADECCO supplies to its clients?”, and ruled that ADECCO supplied employees (labour services) to its clients for which the payments by the clients were in return. Therefore, VAT had to be calculated on the total amount received by ADECCO.
23. The full court judgment may be accessed on:

https://www.bailii.org/ew/cases/EWCA/Civ/2018/1794.html

CASE 3: Citibank, N.A. South African Branch and Another v Commissioner for the South African Revenue Service [2023]

24. Citigroup Inc. (“Citigroup”) is a US-based MNC with operations in various countries and conducts banking business in South Africa through its branch (“Citibank SA”), the Applicant in this case. Citibank SA is registered for VAT in South Africa.
25. Entities within the Citigroup exchange employees on secondment basis. The “sending entity” enters into an intra-company agreement with the “receiving entity” “for supply of employee services” by which the employees are deployed on “expatriate assignment”. The person on secondment remains an employee of the “sending entity”, and a third entity, “Citigroup, N.A”, is responsible for administering the “expatriate salary and benefits”, as “an agent” of the “sending entity” – essentially doing “payroll management. Citibank SA has been a “receiving entity”. The “receiving entity” is invoiced for the salaries and benefits paid to the expatriate employees using “cost-plus markup” methodology.
26. SARS, the Respondent in this case, assessed the Applicant for VAT on the amounts paid in salaries, benefits and mark-up.
27. In the Supreme Court of South Africa, the Applicant challenged the VAT assessment, arguing that even though the expatriates retained their employment contracts with their “home employers”, they were actually employees of Citibank SA. PAYE tax on the salaries and benefits was indeed remitted to SARS. The Applicant also argued that the payments made by Citibank SA to Citigroup N.A (payroll agent) in relation to seconded employees were reimbursement of salary costs incurred by the “sending entities” and were thus not subject to VAT in South Africa.
28. On the other hand, SARS argued that the expatriates were not employees of Citibank SA, and that the payments made by Citibank SA to the “sending entities” (via Citigroup N.A) were for “services rendered” (the “service” of making the expatriates available to Citibank SA). Decision of Court
29. The Court concluded that Citibank SA did not provide convincing evidence to show that the expatriates were actually its employees, and to prove that the payments made to the “sending entities” simply constituted reimbursement of salaries. The Court found that Citibank SA paid for “imported services” in the form of employee secondment, for which VAT was due and payable on the entire amount paid out.
30. The Court judgment may be accessed on:

https://www.saflii.org/cgibin/disp.pl?file=za/cases/ZAGPPHC/2023/1209.html&query=%20citi%20bank

Observations and conclusion from the above

31. From the above court judgments, it seems reasonable to interpret the phrase “consideration paid in money” that is stated in Rwanda VAT law, to mean the full contract price that is usually stated in the contract for “supply of labour” – commonly referred to as “labour outsourcing services”. This typically includes the reimbursable salary and the management fee.
32. Therefore, in our illustrative example of LHC and ABC, the contract price is RWF 33,000,000 – which includes the amounts payable to the employees in salaries and the management fee. This would mean that VAT due should be RWF 5,940,000, and not just RWF 540,000 calculated on RWF 3,000,000. The VAT would be due from LHC, which would be entitled to invoice the same to ABC.
33. Let us assume that LHC in our illustrative example is a company incorporated and resident in Rwanda, and that ABC is a non-resident company with activities in Rwanda, but without local presence – whether through a branch or subsidiary. This is possible with offshore companies that secure business contracts in Rwanda, or carry-out marketing campaigns of their products in Rwanda using labour supplied by a resident LHC.
34. In the scenario of non-resident ABC, the LHC would be the “employer on record”, ABC would be the ultimate employer. Otherwise, how else would the reimbursement of salaries paid by LHC to the staff in Rwanda be justified? Aside from the matter of VAT, this scenario would raise questions about the Permanent Establishment (PE) status of ABC – the concept which, for now, we reserve for a subsequent discourse.
35. In conclusion, one may ask whether the decisions in the above court cases are binding in Rwanda, and the answer to this question is best given by experts at law. For non-experts at law, however, it may be prudent to use the above court judgments as lessons to learn from, given that there have not been similar cases in Rwanda. Such judgments are particularly important to inform the formulation of tax policy, tax legislation and Commissioner General circulars/rules to clarify the provisions of tax law that may be non-specific or controversial.

About the author:

MBA, B.Com (accounting), CPA, Certified Tax Administration Assessor

Dan is a senior accounting & auditing professional with experience spanning over 30 years. He is a senior consultant in taxation and researches extensively on taxation matters. He has taught at colleges in Kenya & Uganda, preparing students for CPA professional examinations.

About the reviewer:

Paul Frobisher Mugambwa; MBA, BSc (accounting), FCCA

Paul is a senior consultant in taxation with experience spanning over 17 years. He has authored the book: “Value Added Tax in Uganda: a commentary on statutes, case law & practice”, and is a regular speaker on taxation matters covering East and Southern Africa emerging markets. Paul is the current Chair of the Tax Committee of the Institute of Certified Public Accountants of Rwanda.