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?
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
