Finance Bill Sub-Committee blames IR35 for ‘concerning’ rise in umbrella company contractors

The government must do more to protect umbrella workers in the wake of a “concerning” uptick in the number of contractors operating through payroll processing companies since the onset of the IR35 reforms in the private sector.

That is according to the House of Lords Economic Affairs Finance Bill Sub-Committee, which – in the wake of its latest inquiry into the IR35 reforms – is urging the government to pick up the pace of its commitment to rolling out statutory regulation for umbrella companies.

The sub-committee’s inquiry set out to assess the impacts of extending the IR35 reforms to the private sector in April 2021, and one of its major findings was that the decision led to a surge in the number of contractors working through umbrella companies.

Many medium-to-large private sector organisations took steps to tweak their hiring polices ahead of the reforms coming into play, in order to minimise the additional administrative burden that complying with the changes would potentially generate.

That is because the reforms shift responsibility for determining how limited company contractors should be taxed away from the individual and onto the end-hirer, based on the work the contractors do and how it is performed.

Previously, it was down to contractors to decide for themselves whether they should be taxed in the same way as salaried employees (inside IR35) or off-payroll workers (outside IR35).

Some private sector organisations have sought to absolve themselves from having to decide how the contractors they engage with should be taxed by introducing hiring bans that prohibit the use of limited company contractors in favour of those employed through umbrella firms.

The sub-committee’s inquiry confirmed that such hiring policies have resulted in more contractors being employed through umbrella setups since the roll-out of the IR35 reforms in the private sector, which it said was concerning because of the prevalence of “rogue umbrella companies” in the market.

“The sub-committee is very concerned to note that the extension of the off-payroll rules to the private sector is resulting in greater numbers of people using umbrella companies, and increasing the risk that some individuals, particularly those on low incomes, will become involved with rogue umbrella companies associated with tax avoidance,” the sub-committee wrote in a 14-page letter, addressed to Lucy Frazer, financial secretary to the Treasury.

This concern relates to past instances of contractors being lured into working for umbrella companies that are effectively fronts for tax-avoidance schemes, which offer “too good to be true” take-home pay rates by paying part of the contractor’s salary in tax-free loans.

And because the IR35 reforms are designed to prevent tax avoidance occurring as a result of contractors deliberately misclassifying themselves as being “outside IR35” to minimise their employment tax liabilities, the sub-committee said the surge in umbrella company usage risked “substituting one form of tax avoidance for another”.

It added: “The sub-committee is very concerned that the off-payroll rules are encouraging the insertion of unnecessary intermediaries in the supply chain, adding to costs and opportunities for ‘rogue’ operators. We believe that effective action requires a stronger focus on worker protection.”

The government is in the midst of a consultation, launched in November 2021, into how the umbrella company sector works, to inform the government’s thinking on what shape statutory regulation of these organisations should take.

The sub-committee referenced this consultation in its letter to Frazer, but said it would have liked to have seen a “greater focus on the protection of workers” employed by umbrella companies and a “clearer indication of the government’s intentions” when the consultation’s call for evidence was launched.

“The sub-committee feels that the government has been slow to act against the harm caused by the activity of non-compliant umbrella companies,” said the letter.

“We recommend an early indication of what use the government intends to make of the information it collects, what action is proposed and to what timescale.”

The letter added: “In the absence of effective statutory action, umbrella companies are proliferating. More and more individuals are at risk of getting caught up in tax-avoidance schemes.

“The government needs to commit to a date for bringing forward legislation to create the proposed single enforcement body to regulate umbrella companies.”

The sub-committee’s findings and conclusions are based on the written evidence it received from more than 30 contracting market stakeholders, ranging from trade associations to individual contractors, during November 2021 and several oral evidence sessions in December 2021.

Sub-committee chair Lord Bridges of Headley said the government must act swiftly to push through regulation for umbrella companies to prevent new mechanisms of tax avoidance emerging.

“The whole point of the off-payroll reforms was to crack down on tax avoidance,” he said. “Yet it risks giving rise to a new wave of tax avoidance as people – many of them on low incomes – end up in rogue umbrella companies. The government must take action to protect workers from ‘rogue’ operators as a matter of urgency.”

Crawford Temple, CEO of umbrella company compliance accessor Professional Passport, backed the sub-committee’s findings and said the IR35 reforms have created a “perfect storm” that allows “tax avoidance and disguised remuneration schemes to thrive”.

He added: “Along with others, Professional Passport highlighted these threats, which the government simply ignored and now we are seeing the fall-out as highlighted in the Lords report.”

Temple said that although regulation is being heralded in many quarters as the route to better protecting contractors from unscrupulous, non-compliant umbrella companies, much more needs to be done to clamp down on the people who create and run these rogue firms.

“Over the last two years, with the country focused on Covid, there has been a lack of any visible and proactive enforcement, and any enforcement we have seen has been targeted at the workers and not the promoters of the schemes who have been allowed to flourish and keep any money they make,” he said.

“It is time to stop the perpetual cycle of legislation and radically rethink and simplify the rules that work for the benefit of all those in the sector who are striving hard to raise standards and drive out those who consistently seek to break the rules and behave unethically.  Let’s put an end to a sticking-plaster approach to an existing framework that is fundamentally flawed.”

Computer Weekly contacted HMRC for its response to the sub-committee’s findings, and received the following statement from a spokesperson: “The government welcomes the committee’s follow-up inquiry into the impacts of the off-payroll working reform introduced in April 2021. The government will carefully review the conclusions and recommendations of the inquiry and will respond to the committee in due course.”