A shower of truth: government calls for evidence on use of umbrella companies

16 December 2021

The use of umbrella companies is on the rise in the UK. Umbrella companies can support a more flexible and resilient labour market, but some may be misbehaving when it comes to employment and tax laws. This article explains the government’s call for evidence and what the positive outcomes might be.

What is an umbrella company?

There is currently no statutory definition of an umbrella company but, generally speaking, umbrella companies employ individuals to provide their labour for the benefit of an end client. Typically, umbrella companies do not source work for their employees; this is done by an employment business which engages with the end client. The umbrella company is then engaged by the employment business to employ the individuals, pay their salaries and account to HMRC for the appropriate tax, National Insurance contributions and apprenticeship levy, where applicable.

Why might you use an umbrella company?

We have seen the use of intermediaries, including umbrella companies, increase significantly in the UK’s labour market.

This is partly to avoid the extra administrative load of IR35. The new IR35 rules put the responsibility on the end client to make assessments about the status of contractors operating through personal service companies (PSCs) and, in some circumstances, operate PAYE and NICs on their fees. Following the introduction of the new IR35 rules, some end clients are taking active steps to remove all PSCs from their supply chain. Umbrella companies are an attractive option for those end clients, because the IR35 rules do not apply at all if a contractor is taken on by an umbrella company as an employee. Other end clients are engaging PSC contractors via employment businesses, as the employment business (rather than the end client) then has the obligation to pay the PSC’s fees and tax those fees if IR35 is found to apply. Employment businesses, for their part, may prefer to engage the services of umbrella companies, ordinarily to employ contractors, pay them and tax them (to avoid IR35 altogether); but sometimes to engage contractors operating through a PSC such that the umbrella company would be responsible for tax if IR35 applies. The “traditional” umbrella model is one of employing the individual.

In addition, the pandemic has led businesses to want greater flexibility in their workforce, meaning that they may prefer to use umbrella employees to plug temporary work shortages rather than to hire new employees directly and deal with the associated onboarding process, provision of benefits, dismissal costs and so on.

One estimate contained within the government’s call for evidence puts the number of so-called umbrella employees in the UK in 2021 at over 600,000.

The increasing use of umbrella companies is heightening concerns over areas of suspected non-compliance with employment and tax legislation.

Umbrella companies and compliance concerns

Umbrella companies are required to comply with all tax and employment laws, but there is no specific regulatory framework in place addressing them. The position is different for employment businesses and employment agencies, which are governed by the Employment Agencies Act 1973 and the Conduct of Employment Agencies and Employment Businesses Regulations 2003 (the Conduct Regulations).

If umbrella companies are non-compliant – for example, because they do not provide their employees with paid holiday or sick pay, or do not pay employer National Insurance Contributions – they limit their costs and can, in turn, provide their services at a more competitive price than those who are compliant. This non-compliance can result in the exploitation of employees, a lack of transparency around employee rights and poor market practices.

The call for evidence

The government has called for evidence from employment businesses and end clients about their use of umbrella companies; from individuals about their experience of working through umbrella companies; and from umbrella companies regarding their own practices.

The call for evidence includes questions designed to assist the government in understanding how the labour market is evolving in this area. For employment businesses and end clients, there are questions about the number of workers they engage via umbrella companies, the advantages/disadvantages of doing this and the impact of supply chains becoming longer. For individuals, there are questions about their experience of working through umbrella companies, the “key information document” which employment businesses must provide at the outset and any experience of tax non-compliance.

Where next?

Flexible working models are firmly on the government’s radar. In 2018, the government published the Good Work Plan, in which it committed to bring umbrella companies under state enforcement. There followed a 2019 consultation on establishing a Single Enforcement Body for employment rights and, in June this year, the government confirmed its intention to press ahead with setting up this new body, whose remit is expected to include the regulation of umbrella companies.

The new IR35 rules were brought in during this period and have changed the role umbrella companies play in the labour market. Tax clearly remains a key concern, with certain non-compliant umbrella companies apparently facilitating disguised remuneration schemes, including schemes that involve paying individuals amounts claimed to be non-taxable, such as loans. The government is no doubt keen to clamp down on this misbehaviour.

The responses to this call for evidence from umbrella companies, employment businesses, end clients and individuals alike will be key to understanding what issues the Single Enforcement Body needs to correct and how it should do that. It will also show whether new legislation is needed to govern the behaviour of umbrella companies, in the way that employment agencies and employment businesses are currently regulated.

Where an umbrella company supplies an individual directly to an end client, without an employment business in the chain, the umbrella company takes on the obligations of an employment business as it is the supplier of labour to another party under the Employment Agencies Act 1973 – a point that is not always appreciated by those involved. Greater clarity and guidance on this would be a helpful outcome of the call for evidence.

In our experience, transparency is one of the biggest issues. Since 2020, employment businesses, have been obliged to provide a “key information document” to all work seekers, which brings greater transparency over who has engaged whom, who is paying whom and what sums are being deducted from that pay. However, there is much work to be done here. Individuals engaged by an umbrella company are not always clear who their employer is. End clients contracting with an employment business do not always realise that an umbrella company is involved. And perfectly lawful deductions from the wages paid to umbrella employees can give rise to concern as they are not understood. We have seen numerous claims brought against umbrella companies, employment businesses and end clients relating to employment rights, pay and tax, out of a general lack of understanding of where responsibilities lie. This can end up being a costly affair for everyone.

Umbrella companies, when operating correctly, are an extremely flexible and useful engagement model. It is hoped, however, that the call for evidence will lead to more transparency about umbrella arrangements and encourage the few bad eggs to meet their employment and tax obligations. In the meantime, end clients using employment businesses or umbrella companies should consider an ad hoc audit to ensure (as a minimum) that their tax and national insurance contributions obligations are being met.