Professional employer organisations – a global staffing solution?
26 August 2021
Businesses are increasingly engaging the services of a third-party organisation with responsibility for employing and paying staff and dealing with tax, social security and other such matters. This article looks at reasons for using this option, legal considerations and potential pitfalls.
All companies, wherever they are based in the world, want to staff their businesses in a workable way. Growing numbers, particularly in the UK, are turning to the Professional Employer Organisation or Employer of Record model, but without always realising the legal ramifications. For the purposes of this article, we will refer to entities of this type as PEOs.
This content includes:
- What is a PEO?
- When might you use a PEO?
- What are the legal issues?
- Common commercial terms and considerations
- Beware of time limits and licence requirements abroad
- A global solution?
- How we can help further
A PEO is a third-party organisation contracted to take responsibility for employing and paying employees. This includes dealing with employment contracts, payroll, taxes, visas and sponsorship, benefits and insurances. The PEO employs the individual and supplies them to the end-user company, charging a fee for this service. The end-user retains the ability to direct and supervise the individual on the ground.
There is an employment contract between the PEO and the employee and a commercial contract between the PEO and the end-user, but no direct contractual relationship between the employee and the end-user.
PEOs can be useful when looking to engage individuals abroad. Cutting-edge technology has enabled companies to expand internationally and access new customer and talent bases. The ongoing Covid-19 pandemic has also prompted both employers and employees to try new ways of working and consider different locations for doing so. As a result, more businesses are looking to use staff outside of the countries in which they currently operate.
There are a few ways this can be set up. One option is for the company directly to hire an employee based in a different country to it. This is fine from a UK perspective, but local laws may prohibit it in some locations. Another option is to establish a new company abroad to employ the person, but that is not always convenient or desirable. Local corporate, employment and tax laws can be complex and there are obviously costs involved. The situation may become even more complicated where the employee works in different countries. The PEO model can take care of such gritty obligations, for a fee, which is why growing numbers of companies are using them to expand abroad.
Within the UK, an increasingly widespread reason for choosing a PEO is to avoid IR35 obligations. Where a contractor provides their labour through a personal services company (PSC), large and medium-size end-user businesses must carry out a status determination to determine whether, ignoring the existence of the PSC, the contractor would be an employee of the end-user. If the answer is “yes”, the business needs to account for tax, social security and apprenticeship levy on the fees paid to the PSC. A PEO provides an alternative model in which it (rather than the PSC) employs the individual and supplies them to the end-user – thereby avoiding the application of IR35 and ensuing hassle altogether.
PEOs are also often used to keep down headcount - a common issue among business heads who would like to hire staff but face internal difficulties in doing so.
While there is no doubt that PEOs can be extremely convenient, not everyone realises that depending on the services a PEO provides it may fall within the UK’s legal regime governing the supply of labour. Many European countries have similar regimes, with supply of labour commonly described as “employee leasing”.
In the UK, a PEO will likely be subject to the Conduct of Employment Agencies and Employment Businesses Regulations 2003 (the Conduct Regulations). This is the same regime that governs what is widely known as a “temping agency”, although a PEO may not look or feel like one of those.
The Conduct Regulations are strict and designed to protect both the individual and the end-user. For example, the PEO would need to provide a “key information document” to any work-seekers and be transparent about any transfer fees in the commercial agreement with the end-user. For further information, see our Inbrief guide Staffing solutions and the supply of labour.
In some cases, a PEO may also be subject to the Agency Worker Regulations 2010 (AWR), which derive from EU law. The AWR apply where an individual (other than a genuinely self-employed contractor) is supplied for an assignment by a temporary work agency to work temporarily for and under the supervision and direction of an end user. For general information about rights and obligations under the AWR, see our Inbrief guide Agency workers.
PEOs may be used as a temporary means to an end, such as while a business finds its feet in a new a jurisdiction or because of a lack of headcount budget at the point of hiring. In such situations, the AWR would be likely to apply. Alternatively, PEOs are sometimes used for indefinite engagements, as though the end-user has hired its own permanent employee, in which case the AWR may be less likely to apply if the engagement is genuinely not time-limited in practice.
Under the AWR, from day one of the assignment, the end-user must provide the individuals being supplied with the same access to collective facilities and amenities as it does to its own comparable, directly hired staff. This is a direct obligation on any end-user company, for which it is solely liable. That means that any individual, despite being employed by the PEO, could seek to bring a claim against the company directly for its failure in this respect.
After 12 weeks in the same assignment, a supplied individual receives the right to the same basic working and employment conditions as a person hired directly by the end-user company would receive. The PEO will still pay the individual, but any failure to pay the correct amount could be a joint and several liability between the PEO and the company (depending on whose failure has led to the incorrect pay).
Similar rules apply in other European jurisdictions. In Denmark, for example, the statutory regime under the Danish Agency Worker Regulation obliges the end-user to provide the individual with access to employee facilities (e.g. office canteen, nursery) and to inform them of vacant positions within the company when they become available. PEOs must ensure the individual receives the same pay and benefits as employees of the end-user from the first day of work. This goes further than the AWR in the UK where, as mentioned, there is a 12-week period to get through first.
Moreover, under employee leasing legislation in some European jurisdictions, there are limits on which industries and sectors can engage with PEOs.
End-user companies should be careful that they are contracting which a PEO which provides them with what they need. Some organisations offer an “Agent of Record” model, under which they supply individuals as contractors and handle payments on their behalf. This would not be a suitable model for an end-user looking for a third party to employ individuals and carry the liabilities of employer.
Aside from labour supply issues, end-user companies should consider how they will protect their business once an individual’s employment has been terminated. Restrictions need to be drafted to accommodate the reality that, while the end-user is not the employer, it is nonetheless the one that stands to lose if not adequately protected. There is no “one size fits all” for such restrictions, which must be considered on a jurisdiction-by-jurisdiction basis and meet local law requirements. In some European countries, for instance, the individual must receive a compensation payment for the duration of any restriction for it to be enforceable. In other countries, restrictions may simply be prohibited.
In light of the statutory compliance regimes regarding supply of labour, it is good practice for end-user companies and PEOs to ensure that the associated legal risks are addressed and apportioned sensibly within the commercial terms.
We would expect to see the following types of clauses in the commercial agreement between a PEO and end-user company, depending on duration for which the individual(s) will be employed and the relevant jurisdiction:
- Responsibility on the PEO for carrying out suitability checks on the individual worker. This can extend to verifying professional qualifications and confirming whether the individual is subject to any restrictive covenants.
- The provisions that apply if the end-user company considers the individual worker is no longer suitable.
- Responsibility and protection for the end-user company in terms of confidential information and intellectual property.
- What transfer fees may apply if the end-user company seeks to engage the individual directly.
- Requirements around the provision of information between the parties regarding the assignment and the individual. The PEO will want to ensure that the company provides it with the necessary information to allow it to pay people correctly after 12 weeks, where the AWR may apply. It will also want to specify that the cost to it of meeting the requirements under the AWR are passed on to the end user.
- The various agreed fees for the PEO’s services, such as: the general services fee; social security charges which the PEO will need to account for; tax-filing fees; payments specific to the local jurisdiction such as prescribed termination payments or a 13th month payment; and business travel insurance for mobile employees.
- Provision of the necessary certifications by the PEO, particularly in relation to social security and taxes.
- Obligation on the PEO to comply with all local licensing requirements relating to its activities or provide proof that it holds the relevant licences.
- Obligation on PEO to comply with all local employment law requirements when employing the staff being supplied.
- An indemnity from the PEO in respect of any employment claims an individual may attempt to make against the end-user company.
- A clause requiring that the contractual documentation between the parties should specify that the individual’s employment will remain with the PEO throughout and not the end-user company. The documentation also needs to be clear that the relationship will not at any point resemble one of co-employment or joint employment between the PEO and end-user company.
Regarding the final two points above, end-user companies should remember that in practical terms an indemnity is only as good as the party giving it. Accordingly, they need to make sure they are comfortable that, were an indemnity to bite, the PEO would be able to honour its obligations under it.
If the agreement is intended to cover several jurisdictions, it may be necessary to use country-specific annexes to cover local regulatory matters.
It is not uncommon for the activities of a PEO to be presented as the supply of services, rather than the supply of labour – whether inadvertently, or deliberately to limit the appearance of a supply of labour. A PEO’s activities may in practical reality amount to both things.
For an end-user company, it may be possible to accept a commercial agreement for the supply of labour in the UK which is presented as a services agreement. However, it is generally advisable to be upfront about the arrangement and certainly advisable to seek indemnities relating to labour supply, the AWR and employment status. In jurisdictions where there are more serious penalties for breach of the law in this area, end-user companies should exercise special caution on this matter.
In the UK, there are no limits on the length of time for which an end-user company can use a PEO. They can be used to engage an individual on an indefinite basis or on a short-term/project basis – whatever is needed. PEOs do not need a licence to supply labour and provide a flexible staffing solution.
The same applies in Denmark, but the position is markedly different in some other countries. For example:
- In Spain, only registered temporary employment agencies can supply labour and there must be sufficient grounds to justify any fixed-term employment contract (which generally cannot exceed six or 12 months). PEOs are not usually registered as temporary employment agencies and often employ individuals on an indefinite basis, so their services are likely to amount to an illegal supply of labour/employee leasing arrangement. In that scenario, the individual is entitled to indefinite employment by the PEO or the end-user company, whichever the individual chooses. The end-user can be held liable along with the PEO for breach of any employment and social security obligations and significant fines may apply.
- In Germany, PEOs that will be supplying labour require a licence to operate. These licences are issued on a time-limited basis, but the PEO may apply for an unlimited licence when one has been extended three times. Employment status is a particular risk area in Germany. Where local statutory requirements and time periods are not followed to the letter, this may lead to a “disguised employment” situation whereby the individual supplied by the PEO is deemed the employee of the end-user (with all the employment and tax-law ramifications that entails).
- In Italy, a PEO may amount to a temporary agency carrying out employee leasing, which is a restricted activity unless the agency is enrolled in a public registry and meets statutory requirements. Both the PEO and the end-user company could face criminal liability where the PEO does not have the required permission to supply labour. There are also time limits for using this model, depending on headcount.
- In Belgium, employee leasing is strictly prohibited save where it falls within a specific exception. These are: (1) a subcontracting arrangement primarily for the provision of services, where any labour supply is not the predominant focus; (2) intra-group leasing; and (3) a temporary work agency which is authorised in advance by the competent authority and supplying labour in one of the few permitted circumstances, such as to cover a temporary increase in work.
PEOs can solve a lot of employment and tax/social security problems for those companies looking to expand outside of the UK or to avoid the burdens placed on them by the recent IR35 reforms. They should, however, be used in the full knowledge that labour supply legislation may apply. When the PEO will be providing a global service, special care should be taken to understand local law requirements, which can have significant consequences if breached.
At Lewis Silkin, we can advise on all aspects of arrangements between PEOs and end-user companies, including reviewing/negotiating commercial terms and outlining employment and tax/social security obligations. Through our membership of the Ius Laboris alliance, we can provide access to expert advice on the rules and requirements applicable to PEOs in jurisdictions across the globe.
With thanks to our Ius Laboris colleagues for their valued input to this article: Till Heimann, Kliemt (Germany); Yvonne Frederiksen, Norrbom Vinding (Denmark); Inger Verhelst and Julie Van Coillie, Claeys & Engels (Belgium); Javier Alonso de Armiño Rodríguez, Sagardoy (Spain); Marco Sideri, Toffoletto De Luca Tomajo (Italy).