Proposals to tackle umbrella company non-compliance: what’s the impact for the recruitment industry?

David Williams-Richardson, employment solutions expert, highlights the details behind the government’s proposals to tackle non-compliance in the umbrella company market and what practical steps businesses in the recruitment sector can take to prepare.

On 6 June 2023, the government issued a new consultation titled ‘Tackling non-compliance in the umbrella company market’. But it would be a mistake to assume this is only of interest to umbrella companies as it could impact any organisation that supplies or hires temporary staff or is in a chain with contingent or off-payroll labour.

The document sets out options for future regulation in the supply chain, covering both employment rights and tax. The closing date for responding is 29 August 2023. The document is a hefty 54 pages in total and includes 52 questions, plus a summary of responses to the November 2021 call for evidence, which closed in February 2022. 

Background

Umbrella companies remain a very popular payroll service for temporary workers, contractors and staffing agencies in the UK. Estimates suggest that more than 500,000 people, ranging from nurses and teachers to care workers and consultants, now work through umbrella companies, with some reports suggesting that there are around 800 operational umbrella companies in the UK. 

Why regulate? 

While most operators in the sector are compliant, umbrella companies have received bad press over recent years around issues including disguised remuneration schemes (such as the contractor loan arrangements), national insurance contributions evasion, denying of holiday pay and abuse of the VAT flat rate scheme. The consultation document also refers to misuse of VAT reliefs and joint employment schemes, which the government see as on the increase. 

HMRC’s Fraud Investigation Service is actively using both its civil and criminal powers to challenge those involved in mini umbrella company fraud and has deregistered hundreds of mini umbrella companies who it believed were involved in one or both of the following:

• exploiting the VAT flat rate scheme; or
• exploiting the employment allowance.

When issuing the consultation document, the government explained that they, ‘want to encourage a flexible, dynamic labour market, but this aim should not be achieved at the expense of workers. New ways of working must lead to fair outcomes for workers while guarding against abuse of the new systems by fraudulent participants.’ 

The objectives of the consultation are therefore focused on delivering improved outcomes for workers, to protect against loss of tax and NIC revenue and to ensure that there is a level playing field for those involved in the labour supply chain.

The key proposals in the consultation document cover:

• regulation of umbrella companies for employment rights purposes, including enforcement standards and models;
• mandating due diligence, a requirement for recruiters or their clients to undertake mandatory due diligence on umbrella companies, with penalties if they fail to do so;
• transfer of tax debt that cannot be collected from an umbrella company to another business in the labour supply chain, including potentially the end client; and
• deeming the employment business to be the employer, treating recruiters as the employer for tax purposes and holding them responsible for any irregularities in payroll, even if they used an umbrella company to perform.

Timing of any changes

While no specific dates for change are mentioned in the consultation document, in view of the level of concerns raised it is feasible that draft legislation could be issued towards the end of 2023, with legislation introduced in the Finance Bill 2024 with an April 2024 start. Any delay beyond this could be impacted by the pending general election and a potential change of government.

Regulating umbrella companies for employment rights

Most umbrella companies are unregulated, unless their activities bring them under the scope of the regulations which apply to employment agencies and recruitment businesses. Concerns were raised following the government’s call for evidence, that a minority of umbrella companies are actively non-compliant with employment rights obligations (for example, withholding holiday pay entitlement) and that workers do not have the means to enforce their rights.

The government is therefore proposing to tackle this non-compliance by introducing regulations containing the minimum requirements that umbrella companies must comply with. The initial areas of focus would be handling of pay and holiday pay, removing the practice of additional services being a condition of engagement with the umbrella company, and a positive duty to pass on the Key Information Document provided by the employment business.

Proposals for dealing with tax non-compliance

The consultation sets out three key proposals for tackling tax non-compliance. 

1. Mandatory due diligence

The government is considering the introduction of a mandatory due diligence requirement, which would be the obligation of either an employment business or the end client using the services, with penalties applying to those that do not comply. The document states that the government would support businesses by providing guidance, setting out due diligence principles and how to demonstrate compliance. However, there is a lack of detail around many features including what checks would be included and how frequently these would need to be undertaken. 

2. Transfer of tax debt  

The second option is to legislate to give HMRC the power to collect an umbrella company tax debt from another business in the labour supply chain, in specified circumstances. It is expected that this would be similar to the arrangements already in place in relation to the off payroll working (IR35) legislation. However, the scope could be extended to cover additional tax such as VAT. 

Introducing debt transfer provisions would likely encourage employment businesses and end users to be more selective about the umbrella companies they contract with. The question is to whom the debt would be transferred; the employment business which supplies the worker to the end user or someone else? 

3. Deeming the employment business to be the employer

The third option would deem the employment business that supplies the worker to the end client to be the employer for tax purposes. This option would require a party further up the labour supply chain, for example the agency contracting with the end client, to operate PAYE on payments to contingent workers. 

Whilst this option would likely have a substantial impact on much of the non-compliant tax behaviour in the umbrella company market, it would undoubtedly result in considerable disruption and additional administrative and financial burden in the temporary labour market.

As an inadvertent consequence, this option could encourage a lack of VAT compliance by removing VAT charged by umbrellas to employment businesses. This will need careful consideration, with perhaps implementation of a new domestic reverse (self) charge, as was recently introduced across the construction sector.

What should recruitment agencies do now?  

Recruitment agencies and end-users who engage contingent labour, should ensure that they fully understand the proposals and should consider responding to the questions in the consultation document before the deadline of 29 August 2023.

Agencies should also consider proactively approaching end clients to discuss the proposals in the document now and to seek their views. It is likely that many end clients will look to change their approach to sourcing contingent labour to minimise their own risk and administrative burden based on these proposals. Agencies who start dialogue early will be best placed to adapt to changing client needs and requirements.

Finally, agencies should discuss the potential implications of these proposals internally across all departments. For example, if a mandatory due diligence obligation is introduced who will be responsible for this and will additional resource be required? If the employment business is deemed to be the employer for tax and NIC purposes, will your existing payroll team be able to manage and how will such an obligation impact margins?

In summary, it is likely that change is coming soon and those in the recruitment sector who start to plan now and discuss the proposals with end clients will have a distinct advantage.

To discuss the potential impact for your recruitment business, please contact David Williams-Richardson.