In light of concerns about the levels of compliance with tax and employment law obligations, in November 2021 the government published a call for evidence about the use of umbrella companies. We wrote about this, what an umbrella company is and how you might use it, here. The government has now published its response to that call for evidence. This publication also sets out recent government activity and guidance in this area and, crucially, sets out the government’s proposals for regulating umbrella companies in order to tackle non-compliance with both tax and employment rights.

What is an umbrella company?

Although there’s currently no statutory definition of an umbrella company, it’s understood to refer to a company that employs individuals as part of a chain in which their labour is supplied for the benefit of an end client. Typically, the umbrella company is engaged by an 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. The employment business is still responsible for supplying the labour to the end client. However, it is increasingly common in our experience for umbrella companies to supply the labour to the end client themselves, effectively stepping into the shoes of an employment business (whether they realise it or not).

Although an umbrella company is the legal employer, the individual does not provide services to or for the umbrella company itself. Nevertheless, its employees still have the usual employment rights, and the umbrella company, the normal employer obligations.

Given the lack of a specific regulatory framework for umbrella companies, and the burgeoning market in this area, there have been concerns about the levels of umbrella company compliance with tax and employment laws, as well as general poor market practices.

What did we learn from the call for evidence?

The call for evidence, which closed in February 2022, sought to gather information about the use of umbrella companies from a range of relevant groups, including employment businesses, end clients, individuals, and umbrella companies themselves. Interestingly, of the 400 responses, 354 were made up of individual workers, whereas only 8 umbrella companies and 2 end clients responded.

The responses indicated that the use of umbrella companies was driven by the desire of end clients to pass their responsibilities in respect of workers further down the labour supply chain. Similarly, it was apparent that workers had limited choice over whether to contract with an umbrella company at all, or the specific umbrella to contract with. Responses reflect a trend of employment businesses having a preferred list of umbrella companies in order to avoid having to carry out multiple due diligence processes.

There seemed to be a general consensus that non-compliance or poor practice should be addressed in order to protect workers, and that a standardised regulatory approach should be applied to ensure a level playing field for compliant employment businesses and umbrella companies.

Key findings

Why umbrella companies are used
The reasons given for using umbrella companies were largely cost considerations and administrative ease i.e. in relation to payroll. The increase in these arrangements also appears to be a response to the IR35 rules, in an attempt to take arrangements outside of scope of these rules. By having an umbrella company which employs the individual and accounts for income tax and National Insurance contributions, IR35 is no longer relevant.

Employment rights issues
Responses indicated widespread confusion from individuals about their level of pay and how this was structured, as well as uncertainty about what employment rights were applicable, and even employment status.

Tax non-compliance
There appeared to be an acknowledgement that tax non-compliance is present in the market, with some employment businesses seeking to address this by only contracting with umbrellas they have completed their own due diligence checks on, or those that are accredited by one of the industry trade bodies.

New regulation

Reflecting these findings in the call for evidence, the government acknowledges that the lack of regulation of umbrella companies can lead to negative outcomes for both individuals and businesses. From an employment law perspective, low levels of individual enforcement mean poor practices can go unchecked. The government has therefore issued a consultation on introducing regulation into this market, which is intended to focus on addressing the underlying drivers of non-compliance.

Proposals on which views are now sought include the following:

• Defining an umbrella company: the first step in introducing regulation would have to be establishing a legal definition of an umbrella company so it is clear which businesses will be in scope. Only after this could specific obligations on these entities be introduced.
  
  The government has put forward two approaches: first, using a specific definition which provides that umbrella companies employ or engage an individual with a view to them being supplied to carry out work for a hirer. This definition would be linked to the introduction of four permitted engagement and payment methods in the  recruitment sector, one of which would be an umbrella company arrangement (these can be seen here).
  
  The alternative approach proposed is setting out three conditions, all of which must be satisfied in order for the employer to be an umbrella company. Unlike option one, this definition would not limit payment and engagement options. One concern acknowledged in the consultation is that it might be easier to intentionally structure arrangements in order to be out of scope.
  
  
• Defining standards: looking further forward, the consultation puts forward different options for the minimum legal obligations umbrella companies (as defined by the new legislation) will need to comply with.
  
  The first option is that regulation should initially focus on a few key issues (such as pay and holiday pay), reflecting the key areas of non-compliance and detriment, as highlighted in the call for evidence. For example, umbrella companies would be required to pay individuals even if they have not been paid by the employment business (an obligation already exists on employment businesses to pay ‘work seekers’, which would include umbrellas, even if they have not been paid by the end client). Also, umbrella companies may be prohibited from making entry into an employment contract conditional upon the individual agreeing to pay for additional services offered by the umbrella company beyond their margin (again, mirroring obligations already imposed on employment businesses).
  
  The second option is that the regulations should take a broader approach, covering a wider array of umbrella companies’ involvement in the supply chain. This would set minimum standards about how umbrella companies should perform their function to support employment businesses in meeting their statutory obligations. For example, umbrella companies might be required to share information with the employment business that is relevant to its duty to supply suitably qualified staff.
  
  
• Enforcing standards: the government is seeking views on the body that should enforce new regulatory standards and how proactive this body should be. The government has stated that its current preferred approach is to regulate umbrella companies through expanding the remit of the Employment Agency Standards Inspectorate, which already regulates employment agencies and employment businesses. It’s noted in the consultation that the government previously committed to establishing a single enforcement body for employment rights and that the EAS could be incorporated into this. That said, the government has previously indicated that it is not currently progressing its original plan to create a single state enforcement body and is instead focussing on ensuring the efficient functioning of existing enforcement bodies. But, as the Labour Party has committed to establishing a new single enforcement body if it wins the next election, the plan remains on the horizon.

Tackling tax non-compliance

The call for evidence points to tougher tax avoidance measures that have already been put in place, namely new powers introduced in the Finance Act 2022 that enabled HMRC = to clamp down on promoters of tax avoidance. Following up on this, in this year’s Budget, the government announced its intention to consult on introducing a criminal offence for tax avoidance scheme promoters who fail to comply with a notice to stop promoting a tax avoidance scheme, and expediting the disqualification of company directors involved in promoting such schemes.

The consultation looks to go further in this area, putting forward three key options to tackle tax non-compliance:

• Due diligence obligations: The introduction of a mandatory due diligence requirement, with penalties applying to those employment businesses or end clients that do not comply.
• Transfer of pay roll debt: Giving HMRC the power, in certain circumstances, to collect an umbrella company tax debt (i.e. outstanding income tax and NICs) from another business in the labour supply chain. This would encourage employment businesses and end clients to be more selective in the umbrella companies they contract with.
• PAYE and NIC obligations: Deeming the employment business that supplies the worker to the end client to be the employer for tax purposes, making them ultimately responsible for ensuring the correct operation of PAYE.

What does this mean for the industry?

Driving up standards
The underlying aim of regulating this market is clearly driving up standards in the staffing industry. Some steps have already been taken towards this as, since the call for evidence closed, the government has updated its guidance on working through an umbrella company. The consultation also states that additional guidance and online tools are being explored. From the perspective of employment businesses, the government has indicated that later this year it intends to publish equivalent guidance on how employment businesses can best support employees engaged via umbrella companies, together with best practice guidance on undertaking due diligence on the umbrella companies in their supply chain.

Of course, guidance lacks the teeth and impact that legal regulation will have. Hopefully, tighter regulation will improve transparency and provider greater clarity as to where in the chain responsibility for employment rights, pay and tax lies. Until then, ad hoc audits remain a useful tool for end clients using employment businesses, or umbrella companies, to ensure that (as a minimum) their tax and national insurance contributions obligations are being met. End clients may also wish to build a contractual right of this nature into the commercial terms held with the employment business or umbrella company. Another option is a contractual obligation on an employment business to ensure any umbrella company in the chain is an accredited member of a scheme that helps to raise standards amongst the use of umbrellas, such as The Freelancer & Contractor Services Association.

This consultation closes on 29 August 2023 and can be viewed in full here. Please get in touch to share your thoughts with us too!