IR35: Government consultation on umbrella companies fuels regulation hopes

The government has embarked on a consultation to understand better how the umbrella market works, which is a move that has been cautiously welcomed by contracting market stakeholders

A government push to get a better grip on the the inner workings of the umbrella market has been cautiously welcomed by contracting sector stakeholders, who view the exercise as a positive step towards introducing statutory regulation for payroll processing firms.

HM Revenue & Customs (HMRC), in collaboration with HM Treasury and the Department for Business, Energy and Industrial Strategy (BEIS), has launched a consultation into how the umbrella company market operates and the role these firms play within the wider labour market supply chain.

As part of this process, the government departments have launched a joint call for evidence that runs until February 2022, where employments agencies, end clients and contractors are being encouraged to share their insights and experiences of working with umbrella companies.

As stated in the 40-page call for evidence consultation document, these insights are being sought to inform the government’s thinking on what statutory regulation for umbrella companies should look like to ensure workers that provide their services through these firms are better protected.

The number of contractors working through umbrella companies has markedly risen in recent years, as documented in the report, from around 100,000 during the 2007-2008 tax year to five times that number now, based on HMRC’s own data.

The annex of the report acknowledges the “umbrella company model” became popular following the introduction of the IR35 tax avoidance rules at the turn of the millennium, while the cause of the more recent rise in the number of contractors is not so explicitly stated.

“Individuals and businesses may choose different methods of engagement for a variety of reasons, including allocating tax and employment rights obligations to different entities within the labour market,” the consultancy document stated.

How IR35 changes led to umbrella uptick 

Anecdotally, it is thought the introduction of changes to how the IR35 tax avoidance rules work in the public sector in April 2017 led to an uptick in the number of umbrella company contractors, as these reforms prompted some organisations to introducing hiring bans for limited company contractors.

This is because, post-April 2017, the introduction of the IR35 reforms meant public sector organisations became responsible for determining how the limited company or personal service company contractors they engaged should be taxed.

However, contractors that provide their services through umbrella firms are considered employees of that company. Therefore, public sector organisations that rely on umbrella company contractors are no longer responsible for determining if these contractors should be taxed in the same way as salaried workers (inside IR35) or as off-payroll employees (outside IR35).

Similar changes to the way the IR35 rules work were introduced in the private sector in April 2021, which – in turn – are understood to have led to another surge in the number of umbrella contractors working across the UK.

Umbrella companies are typically tasked with processing the payroll of contractors that are sourced by employment agencies on behalf of end-clients. As such, they are responsible for ensuring the contractors on their books pay the correct amount of employment tax and national insurance contributions (NICs).

However, there have been a number of instances brought to light in recent years whereby bad-acting umbrella companies have sought to abuse their role within the extended contractor-to-end-client supply chain, by making unnecessary and unlawful deductions from their contractors’ pay packets.

There has also been reports of umbrella companies denying contractors holiday pay entitlements, resulting in repeated calls from MPs and contracting market stakeholders for umbrella companies to be subject to statutory regulation to discourage and clampdown on such malpractice.

The government was advised back in 2017 to introduce statutory regulation for umbrella companies by the former interim director of labour market enforcement, Matthew Taylor, and it has come under fire since then for failing to follow through with this recommendation in a timely fashion.

In response to Taylor’s recommendations, the government did agree in December 2018 to expand the remit of the Employment Agency Standards (EAS) legislation, which exists to protect the rights of employment agency workers, to include umbrella workers. At the time of writing, that change is yet to take effect.

The reasons why the government has been so slow to push through statutory regulation for umbrella companies is unclear, with some contracting market stakeholders previously telling Computer Weekly previous attributing it to a lack of Parliamentary time, due to Brexit and the pandemic.

The delay has also been blamed on a lack of “director-level influence” to drive the umbrella regulation agenda forward since Taylor’s departure in January 2021, although the government did announce late last month that Margaret Beels would succeed him in the role of labour market enforcement director.

On top of this, there has been some notable progress in related areas over the course of the past few months. BEIS, for example, set out plans earlier this year to include protection for umbrella workers in its push to create a Single Enforcement Body (SEB) that will protect workers from rogue employers and workplace malpractice.

The fact the government is now following this up with a push to bolster its understanding of how the umbrella market workers with this consultation has been warmly welcomed by the contracting community, who view it as sign that statutory regulation for umbrella companies is on the horizon.

Crawford Temple, CEO of umbrella company compliance checker Professional Passport, said: “This latest call by the government appears to be a genuine attempt to try to understand the challenges that the industry is facing. 

“It is encouraging to hear that the Treasury, HMRC and BEIS will be working together to address the issues, and it is pleasing that they want to hear a broad range of evidence from a whole host of audiences.”

However, while this consultation plays out, the reality of the situation is that many more contractors are at risk of falling victim to non-compliant umbrella companies.

“This call for evidence should not delay the essential need for more visible action and enforcement right now,” he added.

Cleaning up the sector

Lee McIntyre-Hamilton, tax partner at legal firm Keystone Law, said this development is also good news for compliant umbrella companies, which often find their reputations tarnished by the bad actors who engage in malpractice.

“Most umbrella companies are complaint, or at least strive to be compliant when it comes to employment tax,” he said. “However, umbrella companies have gained a bad reputation through a small proportion of miscreants who have sought to deliberately flout the rules for profit.

“Hopefully, HMRC’s focus will help clean up the sector and allow those many compliant umbrella companies to go about their business without their rightful compliance being an unfair competitive advantage,” he added.

Meredith McCammond, technical officer at the Low Incomes Tax Reform Group (LITRG) thinktank, said the consultation should provide the government with an opportunity to firm up the links between umbrella companies and disguised remuneration schemes.

These schemes are linked to tax avoidance, as participants are paid in part for the work they do by their umbrella company in form of non-taxable loans or annuities by as a means of bolstering their take-home pay.

“This consultative approach by government is a great opportunity for it to gather evidence about the actual and current problems with umbrella companies. This must include first-hand evidence from workers who have found themselves in a disguised remuneration scheme. We encourage the government to think creatively about how it can gather insight directly from workers,” she said.

“This consultation should help determine the shape of a future ‘single enforcement body’ regime of regulation and crucially, should prompt HMRC to flex their muscles to deal with disguised remuneration appropriately and robustly.”

Dave Chaplin, CEO of compliance consultancy IR35 Shield, said the government has heard representations from multiple parties on multiple occasions over the years about why the umbrella sector needs regulating, but little progress has been made.

“Let’s hope they will listen now,” he said, as instances of malpractice and reports of new disguised remuneration schemes popping up continue to proliferate.

“We need to close the door on disguised renumeration schemes, but more importantly on payroll skimming and scamming for other non-compliant ones. There are some very simple, quick and efficient ways to do this, but I expect to see considerable pushback from vested interests who have millions of reasons for maintaining the status quo,” he added.

Read more about umbrella companies

Read more on IT legislation and regulation

Data Center
Data Management