The growth of wholly-owned subsidiaries in the NHS

There has over the past 12 months been a dramatic increase in the amount of NHS providers seeking to form new wholly-owned subsidiaries (WOS) to operate ‘back office’ elements of services. The rationale for this could be seen in the financial benefits from a more tax-effective structure for certain services and assets within a WOS and also from increased operational flexibility and new staffing models, both of which have attracted controversy.

Trusts looking to adopt the WOS route are facing increasing political and union pressure as it has been linked with arguments such as ‘privatisation by the backdoor’ and a ‘VAT scam’ by groups who are opposed to the concept. Despite this pressure many trusts are still looking to implement a WOS so why is this the case?

Main arguments in the case for a WOS

1. Tax – the major benefit currently driving the creation of WOS in many areas is the tax advantages to NHS trusts in the use of a subsidiary (e.g. savings on VAT treatment). By using a subsidiary, savings can be re-invested back into the NHS trust potentially making a substantial impact on cost improvement programmes and the ability of NHS trusts to meet their control total. The current models being utilised rely upon the transfer of assets and staff into the WOS with the operation of a healthcare facility contract to maximise tax-efficiency and savings.

2. Staff – the fact that a subsidiary is a separate legal entity means that it has greater flexibility in the remuneration packages it can offer compared with NHS trusts. It is not restricted to certain pay scales and can offer different balances of remuneration to its employees (e.g. bonuses or different combinations of salary and pension benefits). This will enable it to attract staff with the necessary experience required to provide services in a commercial, profitable manner. Flexibility in remuneration will also allow a subsidiary to incentivise innovation within its workforce. It is important to note that any staff subject to a ‘relevant transfer’ of business into a WOS will benefit from the protection of TUPE legislation, which will mean that their employment rights remain intact and they will arrive at the WOS with employment terms that are at least as favourable as those they are currently subject to.

3. Alternative (better) to outsourcing? – outsourcing can be expensive and controversial for NHS trusts who (in addition to the privatisation argument) would need to go through a form of competition/procurement to appoint the outsourcer. In addition, sometimes NHS trusts can find that outsourced services are not performed in accordance with the required standards so by using a WOS the trust can maintain a greater degree of control on services. Further savings and efficiencies generated can be paid back up to the parent NHS trust by way of dividend (or other distribution) and can then be reinvested into NHS services.

4. Improving service delivery – some WOS have argued that using a new service-specific vehicle has given a more concentrated focus on the delivery of the services (such as estates and facilities) to the NHS trust customer and in turn a greater ability to innovate. In their rationale for the WOS, NHS trusts should consider where some of these changes could be delivered without the use of a WOS and where the new structure can deliver benefit over and above this.

5. Expanding service delivery – if a service is established and experienced then it could offer its services to other organisations (e.g. other trusts, local authorities or educational establishments) looking to achieve similar aims, whether that is by way of consultancy-type services or delivery of services such as facilities management and become more income generating. NHS trusts should be careful to keep the scale of this activity under review as it can impact on the treatment of the contracts the NHS trust awards to the WOS under the in-house exemption in procurement law.

6. Governance – a WOS can have a different board composition to its parent NHS trust, allowing it to be managed in a more commercial, sector-specific manner – for example with a focus on estates and facilities which many not have been possible to deliver within wider NHS trust structures.

There is some debate as to whether NHS trusts should have executive directors (and non-executives) from the trust on the board of the WOS and this will need to be reviewed on a case by case basis, determining whether the WOS will be purely internal facing or external and the services which are to be transferred within the WOS. There are a number of governance risks for NHS trust boards to consider in the operation of a WOS which include conflicts of interest, insolvency legislation, shadow directors and directors’ disqualification. We would recommend that the governance model for the WOS is reviewed carefully to ensure it fits within the trust’s current operations and internal governance processes.

Some areas to consider if you are thinking about setting up a WOS in the current climate

• Trusts legal powers to form a company: the powers to create WOS have been in force and operated for years and a number of trusts have utilised them for a variety of services such as pathology, catering, pharmacy and estates and facilities. NHS foundation trusts have clear
   
• powers to form or participate in forming companies under the NHS Act 2006 though we would recommend that there is consideration of the investment and risk issues in the appropriate group at the trust (investment committee) and that if there is a large scale transfer of staff proposed to the WOS there will be consultation and TUPE issues to be dealt with. For an NHS trust there are very clear limitations and restrictions on the use of these powers which would need to be carefully navigated with NHS Improvement so the position is less clear.
   
• Careful consideration must be given to the rationale around the formation of the WOS: what is the business case for the activity moving to a new separate company? What services should be included (or excluded)? There should be due diligence around the staff, contracts and assets/estate which will be impacted by the formation of the WOS and which may need to be transferred into it. Whilst there will likely be accounting and tax considerations in moving to a WOS these should not be the only factors taken into account by NHS trusts as tax legislation/treatments can be subject to change over time. It would be a high risk strategy to base a business case for a WOS (and move large numbers of staff and NHS estate) solely on the basis of the current tax position.
   
• The trust should also consider its communications approach with staff (both the formal requirement under TUPE and in general around the WOS) and the public given the very vocal opposition which has been seen in some areas to the development of the model. Practically the trust should review the board approvals which will be required for the WOS as well as how the Council of Governors is communicated with (even if they have no formal role it would be sensible to engage with them in terms of the benefits to the trust in setting up the WOS). NHS trusts will also require additional approvals in setting up a WOS and will need to factor this into their project plan.
   
• The trust should consider the business of the WOS going forward and who is going to lead it (whether this is an internal candidate moving across or if there is a need to engage someone from outside of the trust). It should also be clear as to how the corporate governance structure and directors of the WOS link back in with the trust as its sole shareholder. Whilst the legal power to form them has been in existence for some time the recent surge in the number of NHS trusts considering and forming a WOS appears in some areas to be based largely upon the initial beneficial tax treatment and potential alternative employment models. These are however just two of a number of considerations in moving to a WOS model and NHS trusts should be clear that their wider business case for a WOS taking into account all of the factors above would still ‘stack up’ without the tax and employment changes.