In 2018, the government committed to regulating umbrella companies following the Good Work Plan. In 2021 HM Treasury, HMRC and the Department for Business & Trade called for evidence on the policy options to regulate and tackle non-compliance in both tax and employment rights by umbrella companies.
Umbrella companies play a big role in the temporary/contract supply chain providing their workers with employment rights and deducting the appropriate tax and national insurance contributions. Unfortunately, some umbrella companies do not operate compliantly which has led to a lot of bad press in recent years, such as offering disguised remuneration schemes or offshore loans which is the most common form of tax avoidance scheme.
A consultation has set out the actions already taken and others under consideration to prevent non-compliance, hoping to deliver improved outcomes for workers, support for the umbrella company market and protect taxpayers from tax losses arising from non-compliance.
The Government sees regulating umbrella companies as a two-stage process:
- Definition of what an umbrella company is
- Determine the minimum legislative requirements for umbrella companies
Definition of an umbrella company
Currently there is no statutory definition of an umbrella company. HMRC describes it as a company that employs temporary workers to work for different end clients. The consultation proposes two approaches to defining umbrella companies for regulatory purposes by looking at:
- How umbrella companies are engaged by permitting only four methods of engagement and payment
- The nature of their activity and applying 3 tests in order to be considered an umbrella company, but with no limit on the method of engagement or payment method.
The consultation sets out both the potential benefits and risks of each approach along with a series of options for the regulatory work that would be applied to umbrella companies.
Regulation
The government is also looking to make regulations containing the minimum legislative requirements for umbrella companies to comply with either targeted to a few key issues or cover a wider range of umbrella companies’ involvement in the supply chain.
Option 1 – Look to set minimum legislative standards in just a few key areas that have consistently been reported to the government as the main issues for individuals employed through umbrella companies.
These areas include:
- Handling of pay and holiday pay – Umbrella companies to pay the individuals all the money owed for the hours they have worked regardless of how the umbrella company structures its contracts and even if they have not yet been paid by the business.
- Use of additional services – prevent umbrella companies entering into an employment contract upon the individual agreeing to pay for additional services offered beyond their margin and require more transparency about the margin up front.
- Key Information Document – Pass on accurate information that recruitment companies require to provide KID forms.
Option 2 – Set up minimum standards for umbrella companies support to recruitment companies so that they meet obligations to provide services and individuals which will wider the range of aspects of umbrella companies’ involvement within the supply chain. No minimum standards have been provided by the government yet, they are seeking views on what aspects of involvement in the supply chain should cover in the regulations. This could be a set of standards that are more targeted before then expanding them after a review period to enable a better balance protecting workers from genuine detriment whilst preserving business flexibility.
The governments preferred approach to regulating umbrella companies is through expanding the remit of the Employment Agencies Standards Inspectorate (EAS), this already regulates employment agencies and employment businesses where umbrella companies are already heavily utilised. EAS would be able to use enforcement powers, in June 2021, the government introduced a civil penalty for breaches under the EAS-enforced regime that resulted in wage arrears. There is interest in whether this should be extended to breaches of umbrella company regulations.
There are also high risks of tax non-compliance in the umbrella company market due to umbrella companies being responsible for processing a vast amount of payments for workers and ensuring the correct tax and NICs are paid to HMRC. Umbrella companies that do practice good compliance are put at a disadvantage to those who do not, allowing the non-compliant to undercut compliant umbrella companies. There are three proposed options for preventing tax non-compliance within the market by changing the incentives and behaviours in the supply chain.
- Mandatory due diligence – many companies already conduct some form of due diligence on the umbrella companies they work with to ensure they are genuine and legitimate but the government are looking to make this a mandatory requirement that would sit with either the end client or the employment business. A penalty will be subject to those that fail to undertake the require due diligence, this could be in the form of a fixed amount or based to the amount of tax that has not been paid by a non-compliant umbrella company. Recruitment agencies might look to engage elsewhere to reduce the risk of penalties.
- Transfer of tax debt to another party in the supply chain – As employers, umbrella companies are required to withhold tax and employees NI from workers’ pay along with paying employers NICs. HMRC face difficulties collecting unpaid tax, whether this be an error, avoidance or fraud from umbrella companies due to the low level of capital held. Non – compliant umbrella companies that fail to withhold and pay the correct tax and NICs, offer disguised remuneration arrangements in order to provide increased take home pay for workers. The challenges faced when trying to collect unpaid tax owed by a non-compliant umbrella company could give HMRC the power to transfer these debts to another party in the supply chain which could cover the payroll taxes that should be accounted for by umbrella companies as employers. This would require a tax debt to be identified by HMRC first before it can be transferred which would most likely take place through HMRC’s normal compliance checks on umbrella companies. This could lead to a significant financial and reputational impact on those businesses to whom the tax debit is transferred, along with further non-compliant behavior from umbrella companies as the knowledge of a tax debt could be transferred is known. On the other hand, this could have a detrimental impact on compliant umbrella companies as recruitment agencies may choose to not use them in their supply chain because of the exposed risk of a tax debt transfer.
- Deeming the employment business, the employer for tax purposes – it is suggested that an effective way to prevent non-compliance by umbrella companies is to stop them from handling gross funds which would be achieved by a party sitting above them in the supply chain who would make the deductions for tax and NICs from the fee paid for the supply of the workers. This would mean that they would not be able to incorrectly treat payments to workers as non-taxable, such as the commonly seen ‘loan’ avoidance schemes, as the tax would have already been withheld and paid to HMRC. This would involve legislating to change the entity in the supply chain that would be treated as the employer for tax purposes and secondary contributor for NICs purposes. The deemed employer would be responsible for these deductions and also for payment of employer NICs, they would still be able to use the services of another business, for example an umbrella company, to calculate these liabilities but would remain responsible for PAYE being operated correctly. Recruitment agencies might decide to move away from using an umbrella company as this option would mean they could explore engaging with another party to run their payroll.
Both the employment allowance and VAT flat rate scheme are targeted by mini umbrella companies who abuse these schemes to benefit from lower employers NICs and VAT. They are both simple to use and rely on self-assessment of eligibility making them more easily subject to abuse by umbrella style companies who are known to disaggregate into smaller entities (mini umbrella companies) to meet the eligibility requirements. Mini umbrella companies typically have a UK-based director when they register for VAT and claim the employment allowance before the director then resigns and a new offshore director is put in place. As the new director is outside of the UK jurisdiction, it becomes difficult for HMRC to recover any VAT or NICs lost from fraud. Employees of these umbrella companies are usually not aware of these arrangements nor do they know who their direct employer is, which allows them to be moved regularly between umbrella companies to help maximise profits from fraud.
The government does believe there is a rational way to target abuse of the flat rate scheme and employment allowance with targeted action and considering legislative changes to address abuse of these by umbrella companies.
Source: APSCo