An analysis of common employment structures used in the IT sector

We have been asked to comment on a number of popular structures and endemic practices within the IT recruitment industry, and the likely interpretation and treatment of these by local country tax and social charge authorities. This tax briefing may be forwarded to those intermediary recruitment consultants who are involved in international assignments, of any length, in the IT sector.

It may also be sent to individual contractors who may hitherto have hired themselves out through personal service companies of which they are sole shareholders, and who now have to make decisions regarding the administration of an overseas assignment. These decisions will clearly impact on their reputation and as a consequence their effective mobility, particularly when working within the EU.

A. Scope
The legitimate concerns of recruitment agencies, which surround the ‘method of supply’ issue, fall broadly into three areas:

  • That they are not implicated in practices which might be seen to evade local-country taxation
  • That the contractual arrangements between the parties do not give rise to commercial risks, which are disproportionate to their margins
  • That the arrangements do not give rise to an illicit method of supply, which is particularly relevant within continental Europe, where the labour markets are highly regulated

B. Generally Held Assumptions

A number of commonly held preconceptions should be addressed at this stage. The recruitment agency should not assume:

  • That because it is unlikely to be viewed as an employer it has no tax related liabilities.

Whilst an assessment for such liabilities would normally be raised against the multi-national client, the client may well have direct contractual recourse against the recruitment agency. The agency will find that recovery from the contractors, or more probably, a shell personal service company, far more difficult.

  • That its contractors are able to avoid local taxation and social security charges because they are resident in the country for less than 183 days

The use of one man service companies, where the contractor is the sole shareholder and director, is open to attack on the basis that the company is in fact managed and controlled by the contractor in the place where he is working. In any event, by virtue of having its sole employee located in a particular country, a permanent establishment for tax purposes is established in that country. The effect of this is that both the profits of the company and the contractor’s personal income will be treated as sourced in that country and fully subject to taxes there.

  • That the foreign tax administration will remain unaware of the contractor’s liabilities because they are only present temporarily

Double tax treaties provide for a proactive exchange of information mainly between high tax jurisdictions and particularly within the European Union. Moreover, there is a recent proposal to amend a Directive to permit one EU country to actually recover its tax debts in another EU country. Member States have agreed to co-operate in the enforcement of tax debts, so if a contractor leaves Germany owing an income tax assessment, and returns to the UK, the German tax administration could contact the UK Inland Revenue, and the Inland Revenue would enforce the tax debt as if it was tax owing to the UK government.

  • That though such practices carry a commercial risk, they are not illegal

The hiring out of short-term labour is illegal in a number of European countries. Also, practices that would be treated as tax evasion rather than avoidance are criminal rather than civil and an intermediary company can easily be seen as involved in such tax fraud.

C. Normal Interpretation under International & Domestic Tax Laws
Service fees generated and paid to the contractor can be seen in a number of ways:

1. The individual may be able to trade as ‘Self-Employed’, in which case the fees will be seen as ‘income in respect of independent services’or ‘professional income’.

Subject to home-country income taxes if present in the foreign country less than 183 days unless there is a fixed place of business in that country where the individual is based. A temporary assignment would not create a fixed place of business which implies a degree of permanence. Presence in that country for more than 183 days would generally create tax residence so that local taxes would be incurred from the commencement of the assignment. The individual would generally be subject to home country social charges, usually for up to two years, without difficulty.

The individual may not be able to pass self-employed tests and may therefore be seen as employee of the client. Payments to contractors will then be seen as net salary payments and will be grossed-up to calculate the employer’s liability to income tax and social charges, potentially doubling project costs. Further ‘book liabilities’ such as redundancy, maternity leave, holiday pay etc, may arise because of the employed status.


Without the usual Certificate of Incorporation there is a possibility that the recruiter may be seen as an employer, particularly if the contracts indicate the sub-ordination of the individual.

2. The individual may attempt to trade though a one-man service company, so that the fees will be seen as corporate income, and the director’s drawings as a genuine employee salary.

Although commonplace, this will not succeed if properly scrutinised. Having a director and majority shareholder who also fulfils the duties of employment may lead to the company being seen as a sham and treated transparently.

All fees after real expenses will be treated as if distributed as earned income, and therefore subject entirely to local country income taxes from day one. They will generally be subject to home country social charges, usually for up to two years, without difficulty.

The individual’s arrangement may be deemed to be a sham after the event in which they were complicit. They are the most obvious targets for the authorities to raise assessments. Again, payments to contractors will be seen as net salary payments and will be grossed-up to reach the employer’s liability. Further ‘book liabilities’ may arise because of the employed status.

Clients will assume that the responsibility for taxes and social charges rests with the recruiter, budgeted for within the agreed fees. An unexpected further liability will damage the relationship leading at the very least to future withholdings or recovery.

3. The One-man Service Company may be located in an Offshore Jurisdiction.

There is an assumption that because of privacy laws or that information in the public domain is limited, that this will prevent proper scrutiny of a company.


As above, except that for those countries who maintain black lists of tax havens, payments to companies such territories is likely to arouse suspicion and be disallowed against corporate fees receivable for their duties. Attempts to conceal facts are unlikely to be viewed as anything other than deliberate and tantamount to tax fraud.

Investigation is likely, if anything, to be more thorough, as an authority will seek to ensure that the offshore company is not connected with the recruiter, and therefore a way of moving profits to a low tax area.

D.The Use of Management Companies
Management companies have evolved to separate the management and also usually the ownership of the ‘employer’ from the individual who is performing the duties. By creating an arm’s-length employer/employee relationship, with varying degrees of necessary ‘substance’, it is possible for the contractor to be treated as a real employee. He may thus benefit from the 183-day rule for example, and be immediately taxed only on the salary being declared by the employer, in respect of those duties. One might reasonably conclude that the very mobility of contractors working overseas provides the most sensible basis for tax planning. For example:

  • assignments where the duties might be split between locations or,
  • where the work-country only taxes local source income or,
  • where the individual is able to shed his home country tax liability provide real opportunities to mitigate the effects of taxes and social charges in a way that will withstand scrutiny.

It is beyond the scope of this briefing note to dissect ‘whole structures’ which are currently in use. Nevertheless there are some less robust structures and practices which form the basis of various solutions, on which we have been asked to comment:


Pension Schemes authorised under Section 615 of ICTA 1988, are intended for use in respect of duties performed overseas, and have advantages not enjoyed by other UK authorised schemes. That is:

  • Contribution levels are unrelated to age, length of service, normal retirement date;
  • Refunded contributions at the end of service are not subject to UK income tax.

Nevertheless, such pension schemes are being used, both routinely and visibly, to achieve contribution refunds, in respect of contractors whose employed status is unclear. This clearly does not reflect the intended use for such schemes. It is also highly doubtful that many countries would treat the payment in the same advantageous way as the UK authorities, and it is of course the country where the individual becomes tax resident when the refund is received, that determines the taxability or otherwise of the refund.
Authorisation can be suspended instantaneously in the event of perceived abuse and if permanently withdrawn, would affect the treatment of all contributions currently held by the scheme.


The simultaneous ‘split’ payments made by either agents or management companies, to contractors or their companies outside the client-country, whilst the resident contractor is still present performing duties, is only legal if the duties reflecting these payments are also performed outside the country and, that that country exempts that income accordingly.

It is immaterial whether payments are paid to the contractor, their company, or held in a trust or similar structure, as the payments are easily linked to the duties. At worst it will be viewed as evasion and at best an agency may be denied a Corporation

Tax deduction because usually, there will be no contractual or commercial basis to justify the payment. Duties performed in the Republic of Ireland and the CIS countries are the rare exceptions to this treatment, although care should nevertheless be taken to ensure such that individuals are not still subject to tax in their home country, as this liability will usually take account of their world-wide income.

There has long been a practice amongst ‘composite companies’, of temporarily issuing shares to pseudoemployees at nominal value, in order that suitable dividends can subsequently be distributed.

Whilst the relationship will undoubtedly be properly documented, it is difficult to see how such dividends would not be re-classified as employment income upon scrutiny by the relevant authorities, particularly in the light of general anti-avoidance provisions in many countries, and the ‘substance over form’ concept in others.

E. Conclusions
Being the organisation which may well have to ultimately bear the liabilities assessed on their client companies, the recruitment agency should satisfy itself that the employment arrangements as described above do in fact exist in contractual form and in fact. Their contracts with the end user client may in fact be contradictory in the relevant provisions as to the acceptability of independent employment arrangements.

For those seeking work in the same country in the future where assessments have been raised but not settled, a responsible attitude by the IT contractor to tax and social security planning may prevent governmental enquiries on ‘negligent avoidance’ (a slightly more acceptable term than ‘tax evasion’ but with the same penalties attached to it!).

In any event though, it is apparent that with proper advice, both tax and social security costs can be minimised. It is key however, that the location, substance, structure and practice of a management company must be commercially normal and that detailed knowledge is required of the domestic, EU and international tax and social charge laws that impact on the treatment of such an assignment.