Spring Budget 2023 preview | Will there be an announcement about UK regulation of umbrella companies?

The UK government considers there has been a large growth in the use of umbrella company arrangements, some of which have undesirable features. We may soon find out what it plans to do about this, possibly around the time of the Budget next week

Kevin Hollinrake MP, parliamentary under secretary of state at the Department for Business and Trade, indicated last month that the results of the call for evidence launched back in November 2021 on the umbrella company market were going to be made known and that the government would make its response "clear very shortly afterwards...we are keen to make sure we have more control over what some of these organisations are doing". It seems very possible there will be further detail at or around the time of the Budget on 15 March.

Government concerns?

The government set out in its call for evidence (CfE) that it is keen on bringing umbrellas under the regulatory regime (with some criminal sanctions) currently administered by the Employment Agencies Standards Inspectorate (EASI). 

The CfE made it fairly clear that there will be further regulations to deal with non-payment of workers, skimming of payroll and non-payment of holiday pay by umbrella companies, with those companies being regulated by EASI, and that accreditation by an industry body is not a guarantee of compliance.

The CfE also pointed out that umbrellas now seem to be the main conduit for the disguised remuneration tax avoidance schemes using loans schemes and similar approaches – these seem to have declined in other areas of business but survive in some umbrella companies and this clearly annoys the government.

The document also repeatedly described mini umbrella companies (MUCs) arrangements as tax fraud and said MUCs are operated by "organised criminals" and involve National Insurance contributions evasion and VAT Flat Rate scheme fraud. This has been called out for some time by HMRC and the document refers to recent arrests of people involved in MUCs. Anecdotal evidence suggests these arrangements are still springing up in many staffing supply chains.

The CfE also highlighted payroll fraud – that is, just not paying tax; VAT exemption misuse, for example in medical staffing; and joint employment schemes, which the government can see have been on the increase and which the government wants to learn more about.

How far will the government go?

There are a wide range of questions as the Spring Budget approaches about what the government will do next and how far it will go in any future regulation of umbrella companies.

Will tax compliance measures be added to the list of things a new regulatory regime addresses? What about the Working Time Regulations (holiday entitlement), the Pensions Act, the National Minimum Wage (NMW), modern slavery and General Data Protection Regulation compliance?

Will this be the moment that the government also takes forward proposals to merge EASI, the Gangmasters and Labour Abuse Authority and the NMW team at HMRC? The business secretary, Grant Shapps, was reported in December 2022 to have shelved this plan, but it is hard to see how enforcement of umbrella tax compliance could be fully effective without a single enforcement body.

Will the government go as far as proposing a licensing regime with an approach similar to that in the gangmaster legislation? Will end users or staffing companies be penalised for using workers operating via unlicensed or non-compliant umbrella companies? Or will the government outsource compliance by introducing a regime that makes end users at the top of the chain liable for tax and other non-compliance of umbrella companies further down the chain (as with the 2017 and 2021 IR35 regimes). Rightly or wrongly, making risk averse corporates liable tends to influence the market. Will a chain-leasing rule (similar to that in place in some EU countries) be introduced that prohibits more than one entity in the labour supply chain between worker and end user? (This would be very disruptive for managed service provider (MSP) models – even the public sector uses MSPs which engage contract workers via second tier suppliers).

Perhaps most importantly will the regulator have more resource and greater ability to enforce and punish? How will the government deal with the practical difficulty of needing to investigate each individual umbrella, which, as seen with the pre-2017 and 2021 IR35 regimes, stacks the odds in favour of non-compliance given the increasing numbers of umbrellas. For example, if there is fraud, the Criminal Finances Act (CFA or the "corporate criminal offence") already applies but so far there has not been much obvious action yet under that legislation which suggests that a key problem is lack of HMRC resource rather than lack of legislation.

Devil in the detail - defining an 'umbrella company'

Perhaps the biggest challenge for the government is how to define "umbrella company" ? If it is narrowly defined, creative operators of various unlawful schemes will find loopholes. But if, to eradicate loopholes, it is widely defined to include any organisation that seconds workers to work for third parties then that would potentially capture a wide range of consultancy businesses (including law firms) and many government departments, as well as traditional staffing businesses and so-called employers of record (EORs). 

And the government will need to spell out how any new umbrella regime will (if it covers tax compliance) interplay with HMRC's enforcement of existing tax legislation, notably IR35, the agency worker tax legislation (sections 44-47 ITEPA), sections 339A ITEPA (travel expenses), the managed service company (MSC) tax regime, the Construction Industry Scheme, the CFA, VAT, the disclosure of tax avoidance schemes regime, DOTAS, and others?

The commercial impact?

If an effective regime is introduced, covering tax compliance as well as other issues, then some or all of the following outcomes are possible:

• Dodgy umbrellas will disappear. This may be wishful thinking – they do have a knack of "phoenixing" and there may be a surge in even more questionable offshore schemes as a result of new legislation, with use of devices like crypto currency to try to evade tax. However aggressive tax schemes via umbrellas may become a lot less common in many sub-sectors.
• End users who, knowingly or otherwise, currently rely on umbrellas that use more aggressive tax schemes and other non-compliant engagement models to keep labour costs down may decide to prohibit any use of umbrellas in their supply chains. This may lead to supply chain inflation in sectors like food supply and healthcare supply (and further labour shortages if the extra tax is deducted from worker pay making relevant workers move on). 
• Some staffing companies may decide to take more or all payroll in-house, using specialist payroll software companies to support this and, perhaps, software licensed from umbrella companies. (Some staffing companies are doing this already, sometimes as a result of end-user concerns about over-long supply chains).
• Will staffing companies that relied on that sort of umbrella lose market share leading to consolidation of the sector and greater market share for better-established players?
• Will there be more certainty about whether the models of more well-established umbrellas are lawful and less competition from unfeasibly cheap competitors – leading to investments in better-established players in the sector and further acquisitions by US EORs?

Osborne Clarke comment

It is not yet clear when or whether any new regime will be introduced, but it is looking likely that something is coming and we can expect, at the very least, the government's response to the consultation which may set out the direction of travel or more detailed plans. There is a strategy from government and HMRC to enforce compliance in off-payroll staffing supply chains (IR35 reform, the dusting off and application of the agency and MSC legislation, renewed focus on CFA compliance in HMRC's "Business Risk Review" Plus process for large corporates) and it is inevitable that umbrella non-compliance will at some stage be addressed at a structural rather than individual enforcement level. 

Therefore umbrella companies and businesses that rely on them need to get ready for the possible changes. And even if nothing very meaningful is introduced this year, it seems likely that any new government in the next two years will look to take action in this area. 

Whatever is introduced needs to be effective and to take existing laws into account. Many commentators have pointed out that more effective and visible enforcement of existing laws would start to stamp out the questionable practices the government is seeking to address and would have the benefit of not having to define what is and what is not an "umbrella company". The CFA is in our view an obvious candidate so far as tackling the worst tax non-compliance is concerned. However, it seems that the government is minded to introduce new ways of regulating the industry. 

The key questions are: which types of business will be caught by any new regime and who will be held accountable for failure to comply with any new "regulation" and will it be enforced effectively? As we have stated in the past, it's possible that the government will decide that there needs to be a regime which penalises staffing companies and end users who use unlicensed or non-compliant umbrellas.

We have seen this top-down approach to driving compliance work effectively in the case of IR35. If that approach is taken, it would likely mean that reputable staffing companies would not face so much unfair competition from less reputable ones that use "dodgy" umbrellas to undercut them on price. It would also allow reputable umbrella companies confidently to invest in their businesses so that they can offer the worker support mechanisms that Matthew Taylor, in his independent review of modern working practices carried out for the government in 2017, suggested were necessary if the" gig economy" is to work fairly. 

But would such a regime require the government to bite the bullet and bring into existence a multi-disciplinary, joined-up labour market enforcement authority working with HMRC as well as other areas of compliance, and with greater powers and sufficient resource?