Outsourcing (initial considerations)

Question 1

Your client Melrose Retail Limited (‘Melrose’), which is UK-based, is proposing to enter into a direct outsourcing arrangement to transfer responsibility for its payroll function only. Melrose previously had one employee who dealt with the payroll but this employee has now taken early retirement. Melrose is currently using its external accountants to provide payroll services on a temporary basis with a short-term contract in place. Melrose has undertaken a procurement process and proposes to appoint Taylor Payroll Solutions Limited (‘Taylor’) to take over the payroll function from the accountant when the short-term contract ends.Taylor will provide a service in which they administer the payroll for all Melrose’s employees on provision of relevant monthly data from Melrose. Taylor is also based in the UK.
What is the best advice to give to your client in relation to the transfer of responsibility in these circumstances?
1. * Melrose will need to consider UK controls on exports and whether a licence may be required to facilitate the transfer of assets to Taylor.
2. * Melrose will need to consider requirements in relation to transfer of title, including registration at the Land Registry.
3. * Transfer of data and the requirements of the UK Data Protection Regime in respect of employees will be a significant issue for Melrose in this transaction.
4. * The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) will be a significant issue for Melrose, which will need to identify the pool of its employees to be transferred under the proposed outsourcing.

Answer 1

3. • Transfer of data and the requirements of the UK Data Protection Regime in respect of employees will be a significant issue for Melrose in this transaction.

Question 2

Your client, Higgs Investment Services Limited (‘Higgs’), a private provider of wealth management services, is proposing to enter into an outsourcing in respect of its IT infrastructure with a cloud computing specialist company, IntraPrime Cloud Technology Services Limited (‘IntraPrime’). Higgs wants advice about any specific outsourcing regulation which may apply to the outsourcing.
What is the best advice to give to your client in relation to the application of specific outsourcing regulation?
a) You should advise Higgs that the Network and Information Systems Regulations 2018 (NISR) could apply to this transaction, requiring additional IT security.
b) You should advise Higgs that there is specific regulation relating to the aviation industry which may impact its transaction.
c) You should advise Higgs that public sector outsourcing is subject to specific procurement rules.
d) You should advise Higgs that there are no national laws specifically covering outsourcing.

Answer 2

a) You should advise Higgs that the Network and Information Systems Regulations 2018 (NISR) could apply to this transaction, requiring additional IT security.

Question 3

Your client, SilPharm Medical plc (‘SilPharm’), based in the UK is proposing to outsource its R&D to Cobalt Drug Delivery Systems Limited (‘Cobalt’), which is based in India. SilPharm is reviewing the proposed contract with Cobalt and has asked your advice in relation to supply chain compliance.
What is the best supply chain compliance advice to give to your client in relation to the proposed outsourcing?
a) Although it is advisable for SilPharm to have anti-bribery policies in place, there is no statutory requirement to do so in relation to its activities with Cobalt.
b) It is likely that SilPharm will have to report on its due diligence processes in relation to slavery and human trafficking under the Modern Slavery Act 2015.
c) It is mandatory for SilPharm to include ESG provisions in its contract with Cobalt, including specific reference to the UN Guiding Principles on Business and Human Rights.
d) SilPharm should include an anti-tax evasion clause which will protect it against prosecution.

Answer 3

b) It is likely that SilPharm will have to report on its due diligence processes in relation to slavery and human trafficking under the Modern Slavery Act 2015.

This answer is correct. Although we are not provided with SilPharm’s financial information, as a plc it will certainly fall within the Modern Slavery Act reporting requirements. Answers A, B and C all consider relevant compliance issues for SilPharm but ESG is not mandatory, an anti-tax evasion will not offer full protection and the Bribery Act 2010 applies here. See Introduction to Outsourcing: Regulation and Taxation.

Question 4

• What is Outsourcing?

Answer 4

• Customer – transfer by business
• Supplier – to third party
• Operational responsibility – for provision of function, process or service

Question 5

• What is Business Process Outsourcing?

Answer 5

• BPO is the most common type of outsourcing and refers to the outsourcing of back-office functions

Question 6

Different outsourcing models?

Answer 6

• Direct outsourcing
• Multi-sourcing
• Indirect
• Joint Venture
• Captive Entity
• Build-Operate-Transfer

Question 7

• What is a Joint Venture?

Answer 7

• Joint: it involves two or more parties working together
• Venture: in a common venture – a business or a project

Question 8

• What structural options are there for a Joint Venture?

Answer 8

• limited company
• general partnership
• limited partnership (a particular type of partnership)
• limited liability partnership
• contractual joint venture
• Joint Ventures are bespoke - there is no single legal structure or “joint venture statute.” Every Joint Venture will be different.

Question 9

What is direct sourcing?

Answer 9

 Customer contracts with supplier

Question 10

What is multi-sourcing?

Answer 10

 Customer enters into contracts with different suppliers for separate elements (essentially a series of direct outsourcing)

Question 11

What is indirect sourcing?

Answer 11

Supplier contracts to a different supplier, often overseas

Question 12

What is captive entity?

Answer 12

Customer outsources to a wholly-owned subsidiary and uses local suppliers on a consultancy basis

Question 13

What is Build-Operate-Transfer?

Answer 13

Customer contracts with supplier to build and operate a facility then transfer to customer

Question 14

Issues with direct sourcing?

Answer 14

• What is to be transferred - staff and assets
• What services are to be provided
• The service levels required
• What happens if the service levels are not met

Question 15

Pros of direct sourcing?

Answer 15

• Customer can streamline its operations
• Take advantage of economies of scale achieved by a large supplier
• Focus on the core areas of its business

Question 16

Cons of direct sourcing?

Answer 16

• Heavy reliance on one supplier
• Risk of damage to customer’s reputation
• Costs e.g. of transfer, cross-jurisdictional advice

Question 17

Multi-sourcing issues?

Answer 17

• What is to be transferred - staff and assets
• What services are to be provided
• The service levels required
• What happens if the service levels are not met
• Customer also needs to manage interfaces between different suppliers

Question 18

Multi-sourcing Pros?

Answer 18

• Customer can streamline its operations
• Take advantage of economies of scale achieved by a large supplier
• Focus on the core areas of its business
• May avoid over-reliance on a single supplier
• May be able to negotiate lower value, shorter contracts

Question 19

Multi-sourcing cons?

Answer 19

• Heavy reliance on one supplier
• Risk of damage to customer’s reputation
• Costs e.g. of transfer, cross-jurisdictional advice
• The need for effective management of interface between suppliers can add cost and complexity
• There could be logistical issues – need to think how to provide a level of service for clients

Question 20

Indirect Outsourcing issues?

Answer 20

• What is to be transferred - staff and assets
• What services are to be provided
• The service levels required
• What happens if the service levels are not met
• More likely to be overseas so need to manage cross-jurisdictional element

Question 21

Indirect Outsourcing pros?

Answer 21

• Customer can streamline its operations
• Take advantage of economies of scale achieved by a large supplier
• Focus on the core areas of its business

Question 22

Indirect Outsourcing cons?

Answer 22

• Heavy reliance on one supplier and have less control over them
• Risk of damage to customer’s reputation
• Costs e.g. of transfer, cross-jurisdictional advice
• May be higher risks involved with overseas supplier
• Increased costs resulting from above

Question 23

Joint venture issues?

Answer 23

• Can be various structures including company, partnership or contractual joint venture, affecting pros and cons
• May operate in an offshore jurisdiction

Question 24

Joint venture pros?

Answer 24

• More control than other models
• Benefit from supplier’s knowledge
• Share in profits generated
• Potentially easier exit

Question 25

Joint venture cons?

Answer 25

• Complicated and expensive to set up and maintain
• May be taxation issues

Question 26

Captive Entity issues?

Answer 26

• More likely to be overseas so need to manage cross-jurisdictional element
• Need to manage local suppliers

Question 27

Captive Entity pros?

Answer 27

• Direct operational control
• Can have tax benefits

Question 28

Captive Entity cons?

Answer 28

• Significant upfront set-up costs
• Risk cannot pass to local suppliers

Question 29

Build-Operate-Transfer (BOT) issues?

Answer 29

• Likely to be overseas
• High level of commitment

Question 30

Build-Operate-Transfer (BOT) pros?

Answer 30

• Short set up time
• Benefit from local knowledge
• Relatively low risk

Question 31

Build-Operate-Transfer (BOT) cons?

Answer 31

• Likely to be more expensive
• Operational risks
• Difficulties of transfer

Question 32

What needs to be transferred in an outsourcing?

Answer 32

depend on the particular arrangement

Question 33

An arrangement may involve transfer of:

Answer 33

o employees
o property
o intellectual property
o key contracts
o data and information

Question 34

Legislation governing transfer of employees?

Answer 34

• The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) may apply to the outsourcing.

Question 35

Effect of TUPE?

Answer 35

• The main effect of TUPE is to transfer the contracts of employment of employees involved in the outsourced function to the supplier.

Question 36

Key issues to consider under TUPE include:

Answer 36

• which employees are employed in the undertaking?
• what happens to those who choose not to transfer?
• what liabilities are transferred?
• The customer must consider at the outset which employees may or may not be in the pool of transferring employees at the time of the transfer.

Question 37

How can property be transferred?

Answer 37

• Transfer of title must be in writing (usually by deed), and, in most cases, requires registration at the Land Registry.
• Transfer of leases for a term of more than three years must be by deed and leases of more than seven years are required to be registered at the Land Registry.
• A plan will also be required if the transfer will result in first registration or if the transfer or lease is of part of a title.
• Consent of any superior landlord or lender can be needed, which may require financial tests to be satisfied or a guarantee.
• Transfer of title or leases/licences of property outside England and Wales will be governed by the relevant jurisdiction.
• For moveable property, written assignment is usually sufficient but where assets are leased or charged, the transfer can require the counterparty’s and/or lender’s consent.

Question 38

How can intellectual property be transferred?

Answer 38

• Transfer of UK IP rights generally must be in writing and can require registration at the Intellectual Property Office.
• Transfer of IP licences should generally be by written consent.
• Where the licence is held in the name of another company within the customer’s group approval should be obtained at an early stage.
• Licences of registered trademarks must be in writing and signed by the licensor.
• In relation to other IP rights, a written agreement should be entered into as a matter of good practice.
• Likely to be similar formalities for transferring non-UK IP rights but appropriate advice should be sought.

Question 39

What does transfer of Data and Information involve?

Answer 39

• There are no formalities for transfer or licensing/leasing of data or information.
• Instead, the contract will deal with provision of access to data or information and how it is used.
• If there is IP, such as copyright, in the data or information then this should be dealt with by means of written agreement.
• The customer should also consider the inclusion of confidentiality obligations in respect of the data or information.
• The customer will also need to consider the UK Data Protection Regime in respect of employees, including personal data transferred outside the UK.

Question 40

What does transfer of key contracts?

Answer 40

• The assignment of key contracts must be in writing.
• Any contract to be transferred should be identified at an early stage and its terms reviewed to identify whether assignment is possible without express consent.
• Depending on the terms of the contract, the customer may be able to retain ownership of the contract and allow the supplier to supply the services to the counterparty.
• Consideration should be given as to whether the burden of the contract should also transfer to the supplier, either by novation or express indemnity.

Question 41

• The key regulatory issues that need to be considered when structuring a joint venture are:

Answer 41

• merger control
• taxation
• sector regulations

Question 42

How can merger control apply to outsourcing?

Answer 42

• The Enterprise Act 2002, the UK merger control legislation, may apply to outsourcings.
  o This means that the arrangement may need to be notified to the Competition and Markets Authority (CMA).
• The National Security and Investment Act 2021 provides the UK with the means to scrutinise certain transactions on grounds of national security.
  o This means it may be compulsory or advisory to notify and obtain approval from the UK Government in respect of notifiable outsourcings.
• Consideration will also have to be given to foreign merger control.

Question 43

What sector regulations apply to outsourcing?

Answer 43

• Public sector outsourcing is subject to specific public procurement rules.
• The Network and Information Systems Regulations 2018 (NISR) apply to “essential service providers” (electricity, water supply, gas and transport) and “relevant digital service providers” (search engines, online marketplaces and cloud computing service providers) and requires additional IT security, for example, in relation to cybersecurity.
• Parties will need to be mindful of local legislation in relevant jurisdictions and specify responsibility for compliance.

Question 44

Key tax considerations when outsourcing?

Answer 44

• Transfers of Assets to the Supplier
• Transfers of Employees to the Supplier
• VAT or Sales Tax
• Stamp Duty
• Corporation Tax
  Consideration should also be given to the impact of the proposed outsourcing on any existing tax planning arrangements.

Question 45

What does transfer to supplier mean?

Answer 45

• The transfer of assets from the customer to the supplier means there is an actual or deemed sale.

Question 46

How is the transfer of assets treated?

Answer 46

• The actual price or deemed market value (as appropriate) is treated as disposal proceeds for tax purposes.
  o This can give rise to either a profit or a loss, which means tax is either payable or there may be a relief available.
  o However, this is not usually a significant concern in outsourcings as typically very few assets of value are transferred.
• Customer may be required to charge VAT on the transfer of the assets but again, even when VAT is chargeable, not usually a significant issue because of minimal value of the assets.

Question 47

What happens when transfer of employees to supplier ?

Answer 47

• The supplier becomes responsible for the calculation and payment of the following from the date of transfer:-
• PAYE income tax.
• National Insurance.
• Apprenticeship/health and social care levy.
• Exceptions:
• Supplier makes payments before the business is transferred to it.
• Customer makes payments to the employees after the business has been transferred.

Question 48

What specific assets apply to transfers?

Answer 48

• Corporation Tax
   Companies subject to UK corporation tax on their profits (including gains) are liable to pay corporation tax at 25% (main rate)
• Stamp Duty
   Transfers/leases of commercial real property at up to 5% (12% for residential property).
• Transfers of UK shares in companies at 0.5% (although rarely relevant to an outsourcing).
• VAT
   Usually applies at standard rate of 20%.
   May be recoverable but if not is a considerable cost.

Question 49

• The key regulatory issues that need to be considered when structuring an outsourcing arrangement are

Answer 49

• procurement of supplier
• service levels
• supply chain compliance
• data protection and confidentiality
• insurance

Question 50

What does procurement of supplier entail?

Answer 50

• There should be initial due diligence to establish the scope of the project and the different approaches to outsourcing.
• The customer should draw up a business case, taking into account the objectives, benefits, risks and aims of the project.
• The customer will need to set up a budget and timescale.
• The business case should be used to produce a specification for the project.
• This will be put out to potential suppliers, usually in form of Request for Information (RFI) and/or Invitation to Tender (ITT).
• This will be followed by evaluation of suppliers and agreement of contractual terms.

Question 51

• The customer will wish to make sure there are no issues with the service level, which means giving consideration to :

Answer 51

• Right to monitor and audit and increase if there is an issue with service provision
• Right to take control of the services if there is an issue
• Right to terminate if poor service continues
• There should have a clear, detailed documented division of responsibilities between the supplier and the customer. This may include responsibilities for the customer to adhere to as well as the supplier, for example by providing the necessary data to the supplier.

Question 52

What does supply chain compliance include?

Answer 52

• There are several areas where it would be recommended for the customer to guard against supply chain risks including:
• Slavery and Human Trafficking - the Modern Slavery Act 2015 requires the customer (with applicable thresholds) to report on its due diligence processes in relation to slavery and human trafficking in its business and supply chain and the customer will want to ensure the supplier is compliant
• Anti-bribery and Corruption – customers should have anti-bribery and corruption policies which assist in proving compliance with the UK’s Bribery Act 2010 which are likely to include contractual provisions
• Anti-tax Evasion – less commonly, customers may also include an anti-tax evasion provision but such a clause in isolation is unlikely to be enough to protect from prosecution
• Environmental, social and governance (ESG) - it is becoming increasingly common to find contractual provisions in relation to ESG conduct, which may reference the UN Guiding Principles on Business and Human Rights

Question 53

What governs data protection and confidentiality?

Answer 53

• The two main legislative instruments governing the protection and processing of personal data in the UK are the UK GDPR and the Data Protection Act 2018 (UK Data Protection Regime)
• Where the supplier is acting as a data processor, the UK Data Protection Regime requires certain mandatory terms to be included in the contract or a separate agreement
• In addition to being subject to the UK Data Protection Regime, and potentially other data protection laws such as the EU GDPR, most outsourcing firms handling data on their customers’ behalf are likely to be subject to a duty of confidence towards their customers and possibly third parties

Question 54

• There are numerous different types of policies available in the business insurance market in England and Wales, with the following most relevant to outsourcing:

Answer 54

• Employer’s liability insurance (compulsory for businesses in the UK)
• Land and buildings insurance
• Professional indemnity insurance
• Business interruption insurance
• Public liability insurance
• Directors’ and officers’ insurance
• Cyber-liability insurance