A recent tribunal decision shows that calling an arrangement a “TUPE transfer” does not make it one. Accounting firms and their HR teams should take note. Employment status depends on legal realities, not administrative assumptions. A label on its own will never settle the question.
What happened in this case?
A specialist engineering and inspection business employed around two dozen staff. It had always run its payroll in-house. However, a key team member was absent in early 2019. As a result, the business outsourced payroll to an external provider and later switched to a second one.
Between 2019 and 2022, the business reclaimed the input VAT that these providers charged. It argued that its workforce had transferred informally to the providers. In its view, the providers then supplied that labour back to the business. After making enquiries in 2022, HMRC denied input tax claims totalling over £500,000. The business then appealed.
Why the tribunal dismissed the appeal
The tribunal looked at the economic reality of the arrangement. It found that no genuine transfer of employment contracts had taken place. Records from the time showed no real change. Moreover, the annual accounts still listed the individuals as employees. The business also continued to control its staff day to day. In reality, the providers supplied payroll administration, not labour.
HMRC did allow the business to recover VAT on the providers’ core processing fees. Nevertheless, it disallowed VAT calculated on top of net wages, salaries and National Insurance. Outsourced payroll therefore remains a taxable service. However, businesses cannot use it to create input tax deductions from ordinary payroll costs.
Substance matters more than labels
The key takeaway from Outsourced Payroll is not a TUPE Transfer: Lessons from a costly VAT ruling is simple. Substance always outweighs labels. Supervising staff, handling grievances and keeping dismissal rights all point to direct employment. Directing day-to-day duties does the same, whatever the paperwork says.
Why formalities count
Formalities matter too. Without signed transfer agreements, employment contracts stay with the original employer. Formal contract variations and proper employee consultation are just as important. Furthermore, employers cannot move employees to a new entity without their consent and proper documentation. Outsourcing a back-office function such as payroll does not change employment status. Instead, that only happens through a genuine, documented novation of contracts.
What employers should do next
Above all, written agreements, company accounts and everyday practice must tell the same story. Employers should therefore review any arrangement that routes payroll or staffing through a third party. They should then check that the documentation matches how the relationship actually works. In addition, they should take legal advice before restructuring their workforce. That way, they can avoid both employment disputes and unexpected tax bills.
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