Alongside the raft amendments to the Employment Rights Bill put forward at the report stage, there was an unexpected response to the 2023 consultation on the regulation of umbrella companies and associated amendment to the bill. 

This consultation considered the regulation of umbrella in 3 stages: definition; substance of regulation and enforcement. This will be put into practice through the bill by an amendment to the Employment Agencies Act 1973 which extends the definition of employment businesses to include umbrella arrangements. This change would bring these entitles within the scope of statutory regulation and within the remit of the Employment Agency Standards Inspectorate. 

We explore how this might operate in practice. 

What are Umbrella Companies?

Currently, there is no statutory definition of an umbrella company. However, it’s understood to refer to a company that operates as an employment intermediary, employing individuals on behalf of employment businesses (which are often referred to as recruitment agencies) and end clients. 

Typically, the umbrella company is engaged to employ the individuals.  As the employer, the umbrella company is obliged to pay the individuals’ salaries via the payroll and account to HMRC for the appropriate PAYE income tax, National Insurance contributions and apprenticeship levy, where applicable. The employment business is still responsible for supplying the labour to the end client. Although the individuals don’t provide services to the umbrella, as the individuals are typically employees of the umbrella, they have the usual employment rights and the umbrella has the usual obligations.

Employment agencies and employment businesses are regulated under the Employment Agencies Act 1973 and the associated Conduct of Employment Agencies and Employment Businesses Regulations 2003. Obligations arising from this legislation include the requirement for employment businesses to provide a Key Information Document to agency workers prior to them agreeing terms, which must out a number of pay related facts and details about their engagement. Also, the Regulations set out various steps that employment businesses and employment agencies must take to ensure that the worker is well matched for that assignment. This includes information about experience, training and qualifications as well as logistical details. In contrast, umbrella companies are generally unregulated because they are not finding work for those they employ or engage. 

Why are they used?

This arrangement protects the end client and any agencies in the chain from PAYE and NICs liabilities and the responsibility of operating payroll. Their use has increased significantly over recent years, particularly following the introduction of IR35 to the private sector in April 2021, with businesses often requiring contractors who are inside IR35 (i.e. disguised employees) to provide their services as employees of an umbrella company instead. 

What concerns is this reform aiming to address?

There has been a longstanding government commitment to reform of this industry. The Call for Evidence in 2022 highlighted a lack of understanding among workers about how their engagements worked and who was responsible for providing their employment rights. There were also concerns about the level of administrative charges and deductions their wages were subject to. A further significant concern was tax non-compliance, a concern both up and down the chain. 

This month’s consultation outcome echoes these concerns, identifying the reforms are intended to address:

• Employment Rights: The complexity of the employment relationship under this model makes it difficult for workers to navigate. There is evidence that workers are suffering financial detriments such as wage skimming and withholding of holiday pay, compounded by a lack of transparency over wage calculations
• Tax Non-Compliance: The government’s response also points to widespread tax non-compliance in this market, with non-compliant pay practices including seeking to recover employer NICs costs from the individuals and failing to apply the rules for travel and subsistence expenses correctly. 

What is being proposed?

Defining umbrella companies

The first step towards regulation is setting down a new statutory definition of umbrella companies. The consultation had proposed two options but the government is taking forward an alternative and (apparently) simpler approach via an amendment to the Employment Rights Bill. 

This definition focuses on two elements that are indicative of being an umbrella:

1. That an entity is in the business of employing a person with a view to them being supplied to a hirer. 
2. That an entity is in the business of paying for, receiving or forwarding payment for the services of persons with a view to them being supplied to a hirer. 

This will be achieved by expanding the definition of “employment business” under the Employment Agencies Act to include a concept of “employment arrangements”, which captures the above. 

This is a broad definition, and could equally apply to a personal service company where an individual chooses to work this way and uses an employment business to find them work. 

What will the substance of the regulation be?

The consultation made clear that its first step and primary task was this definition. Although the substance of the regulation that would attach to this was explored, further consultation is needed to clarify what regulation will look like.

The government’s intention is for the regulation of umbrella companies to reflect that of employment businesses. However, the consultation response is ambiguous, indicating that umbrella companies will be regulated in the “same way” as employment businesses and also that regulation will be “similar” to the existing Conduct Regulations. 

What is clear is that the government has identified 3 broad categories of requirements that should be applied to umbrella companies under future regulation:

1. Addressing financial detriments;
2. Worker understanding of the umbrella arrangement; and
3. Ensuring genuine businesses operate in the umbrella market. 

However, the precise substance of this will be addressed in future consultation. 

What about fees? 

How similar the regulation of umbrella companies will be to that of employment businesses at the moment will be particularly important when it comes to the question of fees. 

Employment businesses are prohibited from charging work-seekers for finding them work. However,   umbrella companies typically charge workers for their services and this is fundamental to their business model. If future regulation extends this prohibition to umbrella companies, it could be fatal to the umbrella company model in its current form. 

How will this be enforced?

To give teeth to the regulation there must of course be enforcement mechanisms. The recruitment industry is regulated by the Employment Agency Standards Inspectorate and there was support by the respondents to the consultation for this body to be responsible for enforcing umbrella regulations. 

However, the Employment Rights Bill creates a new state enforcement agency, likely to be called the Fair Work Agency, which would take over this role in the future. As we have written in more detail here recent amendments to the Bill have added further powers to the FWA, adding further momentum to the move towards greater state enforcement of employment rights. 

Tackling tax non compliance

The other key question addressed in the consultation was how to tackle tax non-compliance in this industry. It was announced in the 2024 Autumn Budget that with effect from April 2026 the government intended to take forward to option of placing the tax and NICs responsibilities of the employer with the UK agency that supplies the worker to the end client or, if there is no UK agency involved in the chain, with the end client itself.  This means that the agency (or end client) is responsible for operating PAYE/NICs and would have primary liability for any shortfall in PAYE/NICs. 

This would not prevent an agency or end client from engaging an umbrella company to operate payroll on their behalf. Indeed, many businesses value the ability to outsource this function to umbrellas. However, the legal responsibility for ensuring compliance and paying any arrears together with interest and potentially penalties would rest with the UK agency (or end client).  

This change will mean that businesses who continue to use umbrella companies will need to take proactive steps to safeguard their position and ensure that the payroll obligations are being met. This  requires rigorous due diligence on the labour supply chain bearing in mind HMRC guidance (noting in particular the 10 things HMRC consider that businesses should check).  In addition, the contracts should make it clear that all parties are obliged to ensure tax compliance and provide for comprehensive indemnities if this obligation is not met. 

As the consultation response acknowledges, this measure could simply mean that businesses stop using umbrella companies and instead bring payroll obligation in-house.  This would have a substantial impact on both the umbrella company sector and smaller employment businesses, which have previously preferred to outsource their payroll to umbrella companies due to the lack of capacity in-house. 

How will companies weather the storm?

In terms of preparing for the tax change, the government has indicated that it will publish technical guidance for affected businesses. In the interim, businesses will need to review their labour supply chains to understand where umbrella companies are being used; undertake due diligence on those umbrella companies to ensure that non-compliant umbrella companies are not used going forwards and work with all the parties in the supply chain to develop procedures and practices to ensure full tax compliance. 

However, we will need to wait for additional detail from the next consultation on changes to the Conduct Regulations. 

Although the consultation focuses on umbrella companies, the proposals will also impact on a range of suppliers, potentially including employers of record. The expansion of regulation and newly empowered enforcement bodies will certainly give a range of entities pause for thought on their processes and operating practices. 
 
For more information about the Employment Rights Bill, see Lewis Silkin - What’s in the Employment Rights Bill?