Tackling non-compliance in the umbrella market

After scorching temperatures in early June, the wet weather in July and early August definitely made us realise that the umbrella is and always will remain an incredibly useful tool to protect ourselves against the wind and rain.

Would the same hold up for an umbrella company? Are they and should they remain an essential cog in the supply chain? David Korthals-Clarke - Head of Compliance at recruitment business Investigo - and Chris Bloor - Compliance Director at Parasol - have reviewed the latest Government Consultation and share their views on the direction that needs to be taken in order to realise a more transparent and compliant labour leasing supply chain.

According to Statista, there were estimated to be around 1.64 million temporary workers in the United Kingdom as of May 2023 compared with just over 1.45 million in January 2020. We estimate that there are between 600,000-800,000 employees, working through umbrella companies. This high number clearly shows the value that umbrella companies bring to the table.

Following the Call for Evidence on the umbrella company market, HMRC started publishing worker guidance on working through an umbrella company and it has indicated that it will pursue tougher consequences for promoters of tax avoidance.

The purpose of the latest Consultation is to seek views on proposals to tackle non-compliance with both tax and employment rights by umbrella companies. The objectives are threefold: 1) deliver improved outcomes for workers, 2) to support a level playing field in the umbrella company market and 3) to protect taxpayers from the significant revenue losses that currently arise from non-compliance.[1]

This comes as no surprise as in their own words the Government has already acted to improve the operation of the umbrella company market.[2] VAT fraud, mini umbrella company fraud, lack of transparency in relation to take-home pay and payslip fraud are common examples of wrongdoing by rogue payroll providers.

If we look at the role of the umbrella company in the labour supply chain, it is clear that umbrella companies fulfil an important role in ensuring that candidates are paid compliantly. Despite some of the bad press, the Government have clearly indicated in the consultation paper and in more recent forums, that they have no desire to destroy the umbrella company industry.

We think this is in recognition that if they were to be removed it would have a massive impact on both employment businesses and contractors. There would clearly be a huge hole to fill concerning payroll, including knowledge and expertise. However, more pertinent is the potential risk of increased costs levied to individual workers and end clients where employment businesses would begin to incur increased costs for payroll processing. It could also signal the end for those smaller employment businesses, that typically outsource their employer obligations reducing administrative costs.

From a contractor perspective and given the impact of the Off-Payroll (IR35) legislation, the loss of continuous employment and access to tax-saving measures such as pension salary sacrifice, would eradicate any final benefits associated with contracting.

The UK Government has suggested several options to combat non-compliance and has taken a somewhat structureless approach in doing so.

But first, let us look at the proposed definition(s) of an umbrella company. Where an employment business is defined in law[3], a concise definition of ‘umbrella company’ is currently lacking.

Definition of an umbrella company

The Government has attempted to draft two lengthy definitions or better say descriptions of what constitutes an umbrella company. However, both definitions are flawed in the sense that they give the impression that a recruitment business and an umbrella company fulfil two different roles in the supply chain. That is not always correct.

If we look at what happens in practice, umbrella companies typically employ a candidate on behalf of another business in the supply chain, typically a recruitment business, but in some cases, the umbrella company may have a direct agreement with the end user and no recruitment business will be involved.

Equally many recruitment businesses have invested in their own PAYE operations over the last couple of years and therefore they do not always need the services of an umbrella company. Other than providing work-finding services, they pay candidates via their in-house payroll system.

Furthermore, what isn’t highlighted in the Consultation is that recruitment businesses sometimes employ candidates on behalf of their clients (often referred to as a ‘pass-through’), even where they were not responsible for sourcing the candidates (defined by the Consultation as work-finding services). [4]

In both scenarios, a person is leased out to an end user and paid by another party in the chain who acts as the Employer of Record (EOR). Therefore, is it not safe to assume that both the umbrella company and the recruitment business should adhere to the same employment and tax requirements? Yes, the way business is conducted is slightly different from each other, but the results are the same. An individual ends up working for a third party for which the EOR receives a profit?

It is essential that any proposed definition is worded correctly to avoid any misunderstanding and, perhaps more importantly, to ensure that the more unscrupulous providers are not able to use it for financial gain and to the detriment of the worker and the UK taxpayer.

Therefore, would it not be better to take a more holistic approach and create a more generic definition so that every entity that leases out an employee/worker to another party and (indirectly) pays that worker will be seen as an ‘umbrella company’ and be subject of the proposed regulatory framework?

Licensing scheme

Should the Government not take it a step further and consider either a licensing scheme for labour leasing businesses and adopt the approach the Dutch have taken and thus make any intermediary who is responsible for (indirectly) paying the contractor subject to a certification scheme? [5]

As the Government suggested, what those specific license requirements should cover could be initially limited to a few key issues, think about handling of pay and holiday pay, use of additional services and Key Information Document requirements.[6]? One could also make Return to work (RTW) checks and Agency Working Regulations (AWR) processes part and parcel of a future licensing scheme.

Obviously in order to set up a coherent, flexible and efficient licensing scheme, it requires sufficient knowledge and resourcing. It would be sensible for the Employment Agency Standards Inspectorate (EAS) to have conversations with organisations like the Freelancer & Contractor Services Association (FCSA) and Professional Passport to explore how to shape a future licensing scheme.

Three options to combat non-compliance.

Let us go back a step and look at what the Government has considered what the role of recruitment businesses and end users should be. It has put forward three options:

Mandatory due diligence: Recruitment businesses and/or end users would be expected to carry out due diligence on their umbrella partners. Aside from the fact many recruitment businesses are already doing this by following the Supplier Due Diligence Principles, the question is whether it truly flushes out the cowboys as fraudsters would hardly ever put all their cards on the table; they simply tell the recruitment business or the end user what they want to hear. Equally, could we expect small businesses to have the knowledge to carry out appropriate due diligence? Moreover, would it not be more efficient if due diligence is exercised by an accredited body with expert knowledge as opposed to thousands of agencies who all apply different levels of due diligence?

Transfer of debt: To address the challenges of collecting unpaid tax owed by a non-compliant umbrella company, the government could legislate to give HMRC the power to transfer an umbrella company’s tax debt to another party in the labour supply chain, in circumstances where this debt cannot be collected from the umbrella company itself. The question is whether it is fair for the recruitment business or the end user to carry this liability especially as they typically do not control the acts and omissions of the umbrella company? Furthermore, it is expected that end users will move back all responsibility to the recruitment business and some hirers may even decide to introduce a blanket ban for umbrella companies.

An option that could mitigate unnecessary disruption to the supply chain would be to consider the option of a Guarantee Account or G-account which is something that is used in the Netherlands. This may give both the supply chain as well as HMRC the trust and confidence that the right amount of tax and social security is paid. In doing so, as all labour leasing providers are in scope, end users would be less likely to impose blanket bans on umbrella companies.

Moving PAYE obligations to the employment business: The liability for withholding and paying employment taxes to HMRC ultimately rests with the employment business, even where the umbrella company is instructed to employ on that business’s behalf. This seems to be the most undesirable option as it would negate the need to engage with an umbrella company in the first place. Also, the idea that there are two employers (one for tax and the other for employment purposes) seems to create even more uncertainty.

On the whole, it is hard to see how the three proposals in its current shape strike the right balance between improving outcomes, protecting the integrity of the market and avoiding unreasonable burdens on businesses.[7]

Conclusion

The Government has outlined several actions that could help with mitigating the risk of umbrella non-compliance. However, we recommend that if it were to go ahead with regulating umbrella companies, it should widen the scope of the definition so that every party in the supply chain who is responsible for paying the worker falls under the scope of a new regulatory regime. This would make all companies who financially benefit from labour leasing subject to the same regulations and no particular business model would be disadvantaged. It would be worth it for the Government to conduct a case study on the proposed Dutch licensing model. For more information please read: Supply chain compliance: Certification of recruitment businesses (investigo.co.uk)

The Government has also indicated a couple of other avenues it wishes to explore like due diligence and the transfer of debt obligations. A coherent licensing scheme by a certification body however should render the ‘due diligence requirement’ on the side of recruitment businesses and end users redundant.

However, in the event the Government is still of the view that it wants to pursue the ‘due diligence’ route, it should issue comprehensive guidance and consider certifying businesses that can assist with the verification of payslips/Real Time Information (RTI) records similar to what happened with an Identity Service Provider (IDSP) who can carry out digital RTW checks.

Likewise, where the Government still feels that there needs to be an opportunity to reclaim unpaid taxes from the supply chain, one could consider introducing a ‘transfer of debt’ element but this would have to be compensated by introducing a G-account mechanism so that every party in the chain can manage their risks appropriately.

Given the current political landscape and with a general election looming next year, it remains to be seen whether the Government has the time or appetite to quickly introduce this legislation by April 2024.

It is certain however that in order to ensure that there are no unintended consequences, the Government has to consider the views of all parts of the supply chain. Despite the effects of climate change, in the UK we will need our brolly for the foreseeable

For more information you can read the report on the government website. Responses can be submitted by email to umbrellacompanyevidence@hmtreasury.gov.uk.

[1] Tackling non-compliance in the umbrella company market - GOV.UK (www.gov.uk)

[2] Page 14 of the Consultation.

[3] See the Employment Agencies Act 1973 (‘EEA’) and Employment Businesses Regulations 2003. By virtue of clause 13, subsection 3 of the EAA “employment business” means the business (whether or not carried on with a view to profit and whether or not carried on in conjunction with any other business) of supplying persons in the employment of the person carrying on the business, to act for, and under the control of, other persons in any capacity. For the sake of simplicity, the terms ‘employment business’ and ‘recruitment business’ are used interchangeably throughout this blog.

[4] Consultation, page 20.

[5] Netherlands – Budget 2022 introduces mandatory certification system for temporary employment agencies (staffingindustry.com); Temping agencies must be certified | Business.gov.nl

[6] Consultation, page 25

[7] Consultation, page 12.