When engaging with labour suppliers and off-payroll workers, understanding and ensuring the integrity of their processes is crucial for managing any potential tax risks that could arise. Recognising that upcoming changes to tax and business regulations might leave businesses facing risks, HMRC has issued guidelines on labour supply chain due diligence, highlighting what businesses can do to manage their labour supply chain risks.

What is a labour supply chain?

The labour supply chain exists between the end-client at the top of the chain and the workforce at the bottom of the chain. Often, an end-client’s workforce can be provided by more than one supplier and HMRC uses ‘tiers’ to describe where a business sits in the chain. For example, a tier 1 labour supplier is the business directly contracted by the end-user, but if this business sources labour from another business, a second layer is created – tier 2. If the tier 2 business engages the workforce directly, the chain stops. If not, there could be a tier 3 supplier and so on.

HMRC’s latest guidelines have been issued due to concerns that end-clients don’t always have transparency over their entire supply chains – opening the door for accidental non-compliance. As a result, it has produced additional due diligence guidelines for businesses engaging with labour suppliers.

Who should apply the guidelines?

The guidelines are focused primarily on larger businesses, but apply to any organisation when:

• Engaging labour suppliers.
• Contracting and subcontracting with labour suppliers.
• Undertaking risk management regarding labour suppliers.
• Verifying and on-boarding suppliers.
• Undertaking ongoing monitoring.

What are HMRC’s recommendations?

HMRC’s five main recommendations focus on best practices that can help mitigate labour supply chain risks.

• Due diligence: Carry out comprehensive due diligence on your labour suppliers. This means knowing the businesses that make up your labour supply chains, the length of the supply chain, and how the workforce is engaged and paid, and by whom. It includes verifying the legitimacy of suppliers and checking their tax compliance status and reliability. As part of the verification, you should ask questions of those businesses, but also check their website and Companies House records, requesting certificates and verifying credentials, reference numbers, and other records.
• Contractual clauses: Businesses can ensure compliance by including specific assurance clauses in contracts with labour suppliers. These clauses should outline the expectations and requirements for suppliers, including adherence to tax laws and other regulations. This could also include certain terms and conditions, such as the requirement that workers must be employed and Pay As You Earn (PAYE) operated correctly, or adding rules around when you should be informed where onward subcontracting occurs with another labour supplier.
• Training and communication: People in the business involved in engaging and paying labour suppliers will need to understand the principles and risks. This can include the tax team, HR, finance and/or procurement teams. Support mechanisms might include providing training, encouraging an open dialogue with the labour supplier, and sharing best practices with them to help them comply.
• Risk assessment: Initial and regular risk assessments can help identify vulnerabilities in the supply chain. Businesses should evaluate the risks associated with each supplier and act quickly on any concerns.
• Regular audits: Ongoing monitoring of labour suppliers can help ensure best practices and regulations are always being followed. For example, repeating due diligence regularly on long-term contracts can help businesses pre-emptively identify potential issues.

What are the risks of getting it wrong?

HMRC’s guidance also reiterates the risks associated with inadequate labour supply chain assurance, including tax risks, employment legal risks, health and safety, and environmental risks.

Each business’s tax obligations, such as making and documenting employment status assessments and operating PAYE and National Insurance Contributions (NIC), depend on where it sits in the labour supply chain. But non-compliance can carry heavy penalties, making it imperative for businesses to be aware of the risks. Non-compliance with tax laws, for instance, can result in tax and NIC liabilities arising over several tax years together with penalties and interest charges. In addition, businesses also face the reputational damage of being indirectly associated with tax avoidance schemes and other tax fraud.

To avoid compliance issues, businesses should follow the outlined best practices and stay on top of evolving tax regulations, as these will change as legislation, HMRC guidance and case law develops. For example, on 4 March 2025 the Government proposed significant changes for those with umbrella companies in their labour supply chain to take effect from April 2026. These changes will bring umbrella companies within the scope of the Employment Agency Standards and the Fair Work Agency’s remit, and will move the responsibility to operate PAYE and NIC from the umbrella company itself to the tier 1 labour supplier, reinforcing the importance of businesses bolstering their oversight of labour supply chains.

Next steps for businesses managing risk in labour supply chains

While HMRC’s guidelines offer additional guidance for businesses managing risk within their labour supply chains, its recommendations were not intended to form a checklist. This is because the risks in this area can be dynamic and individual factors and circumstances affect businesses differently. However, as a general approach businesses should consider the following as potential next steps towards addressing their understanding and visibility of their labour supply chains:

• Review the guidelines and take professional advice if required.
• Assess current practices against the guidelines, considering the different types of labour suppliers and off-payroll workers used.
• Develop an action plan to address gaps (if any) with specific steps, timelines and responsible parties highlighted.
• Put the action plan into practice, and make necessary changes to processes and policies.
• Train staff members to ensure they fully understand the new practices and their roles.

Are you looking to better understand your business’ labour supply chain risk profile? Contact Lee Knight or your usual RSM contact and find out how we can help.