Government response to umbrella market consultation flags three options

The UK government will need to ensure any measures introduced to tackle tax non-compliance by so-called umbrella companies do not make it harder for businesses to gain access to labour, a tax expert has said.

Penny Simmons of Pinsent Masons said there is a risk that “disproportionate” new compliance measures could have “unfair unintended consequences” in that regard.

Simmons was commenting after the Treasury, HM Revenue & Customs (HMRC) and Department for Business & Trade opened a joint consultation on tackling non-compliance in the umbrella company market (58-page / 622KB PDF).

Simmons said: “The government’s desire to regulate the umbrella company market is understood and regulation that prevents unacceptable tax avoidance and fraud is welcome. However, it will be important to ensure that the government safeguards against any unfair unintended consequences that introducing transfer of debt provisions and due diligence requirements may create and that the compliance burden on both employment businesses and/or end-clients does not become disproportionate and prevent flexibility across the labour supply market.”

The term 'umbrella company' describes an arrangement under which contract workers are supplied by an umbrella company to an employment business, which then supplies the workers to a business – the client – receiving the services of the workers. The client is invoiced for the work that those workers undertake. The workers are then paid as employees or self-employed by the umbrella company.

Options for addressing non-compliance by umbrella companies in relation to both employment rights and tax are set out in the new consultation. From a tax perspective, while many umbrella companies operate legitimately, those viewed as abusive by HMRC have been known to pay contractors the minimum wage and then supplement each individual's income, significantly reducing the amount of payroll tax collected by HMRC.

The government is consulting on a number of options to improve tax compliance in the market.

One option under consideration is the introduction of mandatory due diligence requirements for businesses that engage with umbrella companies.

Simmons said: “The impact of this would depend on the extent of due diligence required and whether there will be prescriptive requirements. The government has said that it may consider a less prescriptive requirement with guidance for businesses on the level of due diligence that would be considered sufficient. Although a less prescriptive requirement would allow for greater flexibility for businesses, it could also create significant uncertainty for businesses as to what is needed to meet the due diligence requirement. Levels of uncertainty would likely be exacerbated if the guidance was unclear.”

A further option being explored is the transfer of tax debts if tax cannot be recovered from the umbrella company.

“The government seems to favour a debt transfer first to the employment business that supplies the workers to the end client and then possibly to the end-client that receives the services of the workers,” Simmons said.

“A transfer of debt provision could operate in a similar way to those in the IR35 rules and therefore the concept would already be familiar to businesses. However, introducing transfer of debt provisions would significantly increase the tax risks that businesses are exposed to when engaging with umbrellas and would likely induce them to undertake comprehensive due diligence before engaging with umbrella companies – therefore, reducing the prevalence of non-compliant tax umbrellas in the market,” she said.

“It would be disproportionate to have both transfer of debt provisions and mandatory due diligence requirements. Businesses may already have introduced comprehensive labour supply chain due diligence processes to manage increased employment tax risks following changes to the IR35 rules in April 2021,” Simmons said.

The government is also considering proposals which would deem the employment business which supplies the worker to the end-client to be the employer for tax purposes and moving the responsibility to operate PAYE to that employment business.

Simmons said: “The government’s preferred option would be for the employment business that engages with the end-client to be the deemed employer. Such a position would mirror the position in the existing agency tax legislation, where the responsibility to operate PAYE sits with the employment business.”

“Of the three options proposed, this is likely to be the least burdensome from a long-term compliance perspective, since most employment businesses will be familiar with the need to assume responsibility to operate PAYE and this option would continue to allow employment businesses to outsource the administration and operation of payroll services – something they want the flexibility to do – whilst reducing the risk of non-compliant umbrellas entering the market. In the short-term, this may lead to increased compliance, with employment businesses needing to review the payroll umbrella companies that they engage with,” she said.

The consultation is open until 29 August 2023.