Umbrella company consultation: is your labour supply chain tax compliant?

New measures to regulate umbrella companies and improve labour supply chain tax compliance are in prospect – here’s what you need to know

Government consults on umbrella companies

Most ‘umbrella’ companies (i.e. companies that employ workers on behalf of a recruitment agency, which then provides those workers to an end-client) comply with their employment law and tax obligations. Unfortunately, some (often offshore), do not. Following an earlier call for evidence, the Government is now consulting on how it can best regulate umbrella companies to protect workers, level the playing field in the contingent labour market, and protect public revenues. Specific proposals to tackle tax non-compliance include: (i) a statutory requirement for end-clients or recruitment agencies to carry out due diligence on umbrella companies; (ii) the transfer of payroll tax debt from non-compliant umbrella companies to the recruitment agency or end-client; and (iii) imposing PAYE and NIC obligations on recruitment agencies that supply workers who are employed by umbrella companies. This article summarises key aspects of the consultation and what action end-clients and recruitment agencies in the contingent labour supply chain should now take.

Enforcing employment rights against umbrella companies

Currently, there is no state enforcement of employment rights against umbrella companies (unless their activities bring them within the regulatory regimes that apply to recruitment agencies), and it can be 

impractical and costly for individual employees to seek enforcement of their individual employment rights. This can result in umbrella company employees’ rights being breached (e.g. by pay or holiday pay being withheld) without meaningful consequences for the employer. 

The consultation therefore seeks views on how an ‘umbrella company’ should be defined prior to regulations being made to set out minimum legislative requirements with a view to improving the enforcement of employment rights (the specific requirements that would be placed on umbrella companies would be subject to further consultation before new regulations are implemented).

The consultation sets out two approaches to defining an ‘umbrella company’ for these purposes. The first approach defines an umbrella company as:

  • A person or business (whatever their legal form) who may be engaged as a corporate work-seeker by the employment business (i.e. recruitment agency) to employ or engage an individual looking for work; and
  • The umbrella company would employ or engage that individual with a view to them being supplied to carry out work for a hirer, in line with arrangements between an employment business and a hirer.

This approach would also limit engagement and pay arrangements to four methods that the Government considers reflect compliant market practices in the recruitment sector. In summary, this approach would require there be only one person or business in the labour supply chain between the worker and the employment business. And the employment business would be legally responsible for ensuring that no other employment/engagement and payment models were used.

The second approach would set out three tests, all of which would need to be met for the relevant employer to be an ‘umbrella company’ in a given set of circumstances. In summary, these tests are that:

  • Two separate businesses (an employment business and an end-client) are involved in the arrangement in addition to the putative umbrella company;
  • A direct contractual relationship exists between the worker and the putative umbrella company that makes it responsible for paying the worker the agreed rate; and
  • The putative umbrella company receives a commission or fee (or ‘margin’), for their services (which is usually deducted from the worker’s gross pay from the total amount received by the putative umbrella company from the employment business).

Addressing tax non-compliance

The consultation sets out three potential options for tackling tax non-compliance by umbrella companies.

The first option is to impose a mandatory obligation to carry out appropriate due diligence when contracting with an umbrella company with the aim of excluding non-compliant umbrellas from the market. Depending on the specific contractual arrangements, the obligation could sit with either the recruitment agency or the end-client, with penalties imposed for failing to undertake appropriate due diligence. This option would be underpinned by government guidance on appropriate due diligence principles and how agencies and end-clients could demonstrate compliance.

The second option is to give HMRC the ability to transfer a non-compliant umbrella company’s PAYE and NIC debts to another business in the labour supply chain in appropriate circumstances. Again, the aim would be to exclude non-compliant umbrellas from the market as the risk of becoming liable for payroll withholding failures means agencies and end-clients would underscore the need to secure their labour supply chains.

The third option is to deem the recruitment agency that supplies workers employed by an umbrella company to the end-client to be those workers’ employer for payroll withholding purposes, and responsible for the correct operation of PAYE and NIC.

Other proposals

The consultation also sets out proposals to counteract abuse of the NIC employment allowance and the VAT flat rate scheme by ‘mini-umbrella’ companies. 

What should end-clients and agencies do now?

End-clients who engage contingent labour, and recruitment agencies in the labour supply chain who engage umbrella companies, should ensure that they fully understand the proposals set out in the consultation and, should they be taken forward, what they might mean for their existing controls and processes.

For example:

  • Could you identify any entities that are ‘umbrella companies’ under the Government’s two proposed approaches to defining them for employment right enforcement purposes?;
  • For recruitment agencies, if the first approach to defining ‘umbrella companies’ for employment right purposes were to be taken forward, could you confirm that only a permitted employment/engagement and payment model is being used?; and
  • Could you identify current non-compliance by an umbrella company in your labour supply chain in terms of its PAYE and NIC obligations?

What happens next?

This consultation closes on 29 August 2023. Please contact Anne-Marie Robinson, Donna Sharp, Colin Ben-Nathan, or your usual KPMG in the UK contact, if you would like to talk through what the consultation proposals could mean for your business, and what steps you might consider taking now to review your labour supply chain risks. Please also get in touch if there are any points you would like us to consider reflecting in any submissions that KPMG makes in response to this consultation.