UK legislation for new rules combatting tax avoidance by umbrella companies published

The draft legislation (5-page / 216KB PDF) were published on Monday alongside other draft provisions for inclusion in the next Finance Bill. The new rules are expected to apply from April 2026.

Penny Simmons, an employment tax expert at Pinsent Masons, said: “There are no big surprises with the draft legislation. The provisions broadly follow previously announced proposals to make recruitment agencies engaging with umbrella companies when supplying individual workers to businesses legally responsible for ensuring that the umbrella company operates payroll taxes properly and pays the correct amounts of tax to HMRC.”

The new rules apply where an umbrella company is used to supply an individual to provide services to a client business. The draft legislation only deals with amounts payable through the Pay As You Earn (PAYE) system. Additional legislation is expected to be published enabling the UK Treasury to introduce regulations imposing equivalent provisions in relation to both employee and employer National Insurance contributions (both employee and employer contributions).

“Essentially, the new rules will shift the risk of unpaid payroll taxes – and penalties and interest – from the umbrella company to the entity engaging the umbrella. In most cases, the entity contracting with the umbrella company will be a recruitment agency. However, as expected, where there is no agency in the supply chain, the client business would become liable for an umbrella company’s PAYE taxes. Client businesses could also be exposed to the tax liabilities of umbrellas when using non-UK recruitment agencies,” said Simmons.

The new rules will make the umbrella company and agency, or end client, jointly and severally liable for PAYE taxes that need to be paid where an umbrella company is used in a labour supply chain. According to a policy paper published alongside the draft legislation, the government considers that joint and several liability will allow HMRC to pursue an agency in the first instance for any payroll taxes that a non-compliant umbrella company fails to pay. The end client will be similarly liable if contracting directly with an umbrella company.

Simmons said: “It is interesting that the draft legislation uses the term ‘jointly and severally liable’. This suggests that HMRC may not even need to attempt to collect unpaid taxes from the umbrella company: rather, where there is a recruitment agency in the chain, HMRC could save time by immediately requesting payment by the agency. It is hoped that the mechanism and manner by which HMRC will pursue unpaid PAYE liabilities from umbrella companies is clarified when draft HMRC guidance is published.”

“With less than nine months until the new rules are introduced, recruitment agencies and clients should review their labour supply chains and use of umbrella companies. Ensuring rigorous onboarding controls and contractual safeguards will be key to managing tax risks effectively. Affected businesses should consider enhancing due diligence procedures prior to engaging umbrella companies and ensuring that labour supply contracts contain appropriate safeguards. Tax risks could be extensive for recruitment agencies using large numbers of umbrella companies,” she said.

“To reduce risks further, agencies may seek to limit the number of umbrella companies that they engage with. The new rules – particularly the use of joint and several liability – will also likely create a strong incentive for client businesses to route their dealings with umbrella companies through agencies.”

Broadly, the term 'umbrella company' describes an arrangement under which contractors and temporary workers are supplied by an umbrella company to a recruitment agency, which then supplies the workers to a business – the client – that receives 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 contractors by the umbrella company. The publication of the draft legislation follows a policy paper published last autumn which was preceded by a consultation on tackling tax avoidance by umbrella companies in June 2023.

The Treasury has been concerned about tax avoidance in the umbrella company market for some time and considers that the new rules will safeguard significant amounts of tax revenue currently being lost due to non-compliance. The government believes that recruitment agencies can decide which businesses enter their labour supply chains, and that they have the power to prevent illegitimate operators from entering the market. The government believes that making those who can control labour supply chains legally responsible for ensuring that PAYE is properly accounted for will improve compliance in the market.