Umbrellas at the ready: non-compliance in the UK umbrella company market

The UK government issued a summary of responses in June to its November 2021 call for evidence on the role of "umbrella" companies in the labour market, alongside a new consultation on tackling non-compliance in the umbrella company market with employment and tax law. The consultation remains open until 29 August 2023.

Umbrella companies' role 

Umbrella companies perform a useful role in employing or engaging temporary workers on behalf of employment businesses and end clients and in purporting to act as the employer by paying salary and deducting income tax and National Insurance contributions through PAYE (Pay As You Earn). As the “employer”, the umbrella company also assumes responsibility for the workers’ employment rights and entitlements such as holiday pay and statutory sick pay. 

In an ideal world, this should mean that umbrella workers are paid properly but, as the government has recognised, some operators are failing to comply with their employment and tax law obligations, and more needs to be done in order to tackle this problem. The government has already taken some steps, including the new powers given to HM Revenue & Customs (HMRC) to clamp down on the promoters of tax avoidance, as well as a communications campaign to raise awareness among workers about the avoidance schemes offered by some umbrella companies. 

In its response, the government acknowledges the role that umbrella companies play in the functioning of the gig economy and emphasises that it is not seeking to ban umbrella companies. An outright ban would be undesirable but also unworkable, as it would be impossible to define an umbrella for the purposes of a ban in a way that does not capture innocent organisations, including government departments, that second employees to other organisations. Therefore, the government is consulting on other ways to ensure compliance with employment and tax law by umbrella companies. 

Defining an umbrella company 

The government sees regulating umbrella companies as a two-stage process: the first stage requires it to define what an umbrella company is, and the second stage requires it to determine the minimum legislative requirements for umbrella companies. 

The consultation mainly focuses on the first stage. It is not straightforward to define umbrella company. Currently, the term covers a range of different business models, some of which the proposed definitions in the consultation seem to purposefully exclude, such as professional employer organisations and Construction Industry Scheme umbrella companies. 

The government has proposed two options to define an umbrella company. The first option provides a broader definition of an umbrella company and limits the acceptable engagement structures of umbrella companies, placing the burden of ensuring that the umbrella company is engaged on an acceptable structure on the employment business engaging it. The second option involves a more specific definition involving a three-stage test, where, if all stages are met, the business would be considered to be an umbrella company. 

With both options, while the definitions may capture a majority of umbrella companies in a recruitment supply chain, neither is able to capture the full range of models that umbrella companies currently cover. 

In addition, defining an umbrella company leaves it open for deliberately non-compliant businesses to structure their arrangements in order to put themselves outside of the scope of the definition. 

Tackling tax non-compliance

The consultation proposes three options to tackle tax non-compliance by umbrella companies: mandating due diligence, transfer of tax debt and deeming the employment business as employer for tax purposes.

Mandating due diligence

The first option would mandate due diligence to be performed by either the employment business (usually these will be staffing agencies) or the end client, depending on the specific arrangements of the contract, supported by a penalty regime for failure to undertake the required due diligence. 

This may not be the best approach. Although it is better than no checks at all, it is unlikely to completely eradicate bad practice and it is probable that unscrupulous umbrella companies will continue to operate. In addition, there will be a lot of uncertainties for businesses as to what constitutes a sufficient check; for example, the confusion relating to IR35 checks. 

Transfer of tax debt

The second option would be to transfer any tax debt that cannot be collected from an umbrella company to another party in the supply chain. This could work well, if it was combined with the introduction of a licensing regime for umbrella companies with an approach similar to that in the gangmaster legislation, so that end users and employment businesses are penalised for using workers operating through unlicensed or non-compliant umbrella companies. 

Employment business as employer for tax purposes

The third option would be to deem the employment business that supplies the worker to the end client to be the employer for tax purposes. This could also work well but it does not seem to address the need for gig workers to have a single umbrella that they can work with from gig to gig, so that they can build their own pension and training arrangements, and demonstrate to mortgage lenders the consistency of their income. It is also unclear whether this option would involve a move away from umbrella companies acting as the employer and, with it, the removal of umbrella worker employment rights.

Incentives and enforcement

While two of these options have merit, it will be interesting to see whether the government will also take other steps as a result of the responses received, including whether it takes steps to clamp down on so-called “kickbacks”; that is, incentives that employment businesses demand from umbrella companies for adding them to the businesses’ preferred supplier list to clients. 

It is often the umbrellas that pay the highest kickbacks that have the most aggressive tax avoidance schemes, using the savings from these schemes in order to pay the high kickbacks. It would not be surprising, therefore, if the government brought forward legislation to eradicate this practice. 

Enforcement reform?

Will this be the moment that the government takes forward proposals to merge the Employment and Social Innovation programme, the Gangmasters and Labour Abuse Authority and the National Minimum Wage team at HMRC? In December 2022, Grant Shapps, the secretary of state for business, energy and industrial strategy at the time, was reported 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. The consultation invites comment on this.

Finally, the question arises of whether HMRC will be given more resources and greater ability to enforce and sanction. The government will need to deal with the practical difficulty of investigating 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 umbrella companies. 

For example, if there is fraud, the Criminal Finances Act 2017 already applies but, so far, there has not been much obvious action under that legislation. This suggests that the key problem is lack of HMRC resources rather than lack of legislation.

Osborne Clarke comment

There is no doubt that change will come to the regulation of the umbrella company market, but there are still many questions with which to grapple and, as yet, no preferred option as to how best to achieve the government’s aim of a more compliant and better regulated market. 

This article first appeared in the July 2023 issue of PLC Magazine.