Sheltering from the rain: the use of 'umbrella' employees and agency workers
Published on 7th Jul 2021
What are the rights of contingent workforces, the obligations of their engagers and the best way to mitigate supply chain risk?
The growth of the contingent workforce comes amid increasing complexity surrounding employment status, which makes it essential to understand the legal status and the rights of these workers. "Contingent workforces" take many forms and are not limited to those supplied by staffing agencies or direct contractors and consultants. For example, many talent and people-service platforms engage and supply the services of gig workers, with some engaged on an employed or PAYE basis and others on a freelance or self-employed basis.
As with many technology-led market disrupters, compliance challenges and obligations issues are sometimes overlooked or regarded as "inconvenient barriers to business", particularly by start-ups and software-led offerings. However, most people-service platforms have some elements of workplace tax, recruitment regulation and payment-services regulation that need to be complied with. For example, any platform that introduces talent is likely to be regulated under the Employment Agencies Act – a fact that's not always understood or accepted.
There are many different types of platform models operating in recruitment and talent matching and each will have different legal compliance issues. Consultancy businesses are also less likely to identify themselves as suppliers of people even though, in practice, many supply consultants on a time-spent basis (which is why a large number of consultancies need advice on their IR35 strategies). Staff augmentation is staffing under a different name. The legal issues are the same regardless of whether these businesses badge themselves as consultancies or otherwise.
And this is why consultancies and platforms are increasingly engaging with "umbrella" companies as payroll partners who can ensure that gig workers and consultants are paid compliantly. It's important for end users, platforms, consultancies and staffing companies to understand what a compliant umbrella looks like – and the difference between compliant and non-complaint offerings in the market.
This all raises broad questions about the current law on employment, the legal status and rights of these workers, the roles of umbrella and professional employer organisation (PEO) companies, "employer costs" and where legal responsibilities sit, and how businesses can de-risk staffing supply chains and maximise the benefits of contingent working.
These were some of the questions raised in a recent webinar co-hosted by Osborne Clarke's Workforce Solutions group and giant, the workforce management specialist. David Hopkins, a workforce management consultant with giant, chaired the discussion, which included Dan Haslam, giant's group sales director, who is also a member of the board at the FCSA – the UK’s membership body for umbrella companies, limited company accountants and CIS payroll providers.
What is the broad legal status of agency and umbrella workers?
Terminology in the recruitment sector can be confusing. Broadly speaking, staffing agencies that engage and pay individuals and umbrella companies that engage, employ and pay individuals are "employment businesses" as defined under the Employment Agencies Act 1973.
Under the legislation, an "employment business" is one that "employs" individuals for supply and work for and under the control of third parties. This is often referred to as a temp model. An "employment agency", on the other hand, is a business that finds work for individuals and supplies individuals for employment by an end user – usually referred to as the "client".
Staffing agencies operate as employment businesses where they engage and pay individuals – this is often referred to as a PAYE temp payroll. These PAYE temps have the status of agency workers (under the Agency Workers Regulations and the agency worker tax rules). They are also workers for the purposes of the: Equality Act, Working Time Regulations, Pensions Act (jobholders), Apprenticeship Levy, National Minimum Wage (NWC), and Agency Workers Regulations (AWR).
Both staffing agencies and umbrella companies pay employer's National Insurance contributions (ER's NICs) on payments to their agency workers or employees. The funding of this ER's NICs is often a source of confusion for contractors, especially where contractors have moved from a personal service company (PSC) to umbrella company.
Umbrella companies typically employ or engage individuals. Umbrella workers have the same rights as agency workers. If they are employed by the umbrella company under an employment contract then they have full employment rights (as against the umbrella employer) as well.
In terms of legal rights, there is little difference between "workers" and "employees" – although differences include rights around unfair dismissal, statutory redundancy and statutory minimum notice. The main difference, in terms of recruitment regulation (under the Conduct Regulations), between staffing companies and umbrella companies, is that staffing companies offer and supply work-finding services and umbrella companies (usually) don't.
For the purposes of the Conduct Regulations, an umbrella company is often regarded as a limited company work-seeker along with the contractor. This is why umbrella company contractor can, arguably, opt out of the Conduct Regulations, although that remains to be tested in a court.
Workers engaged by agencies and umbrella company workers will (or should) have "worker" or "employment" status for employment law purposes, employment business status for Employment Agency Act purposes, and agency worker status for AWR purposes.
This means that agency and umbrella workers have a statutory right to: the NMW; paid annual leave, pensions automatic enrolment; (after 12 weeks) comparable pay and basic terms to perm equivalent; Statutory Maternity Pay and Statutory Sick Pay; and, in certain circumstances, and TUPE.
They will also be paid subject to PAYE and NICs. Anything that deviates from this or claims to reduce tax liability/maximise take home pay should be viewed with caution. The basic position is that agency and umbrella works should be paid and taxed at comparable rates as end user equivalents.
Any schemes offering to reduce tax or NIC liability or to split or otherwise complicate the way in which the worker is paid may be tax avoidance schemes and should be avoided.
What are umbrella companies and PEOs, and what are their roles in managing a contingent workforce?
There is currently no UK legal definition of an umbrella company, despite recent calls to regulate the industry. One of the challenges is that the term umbrella company covers a range of different business models – some of which are compliant and others which are not . For example, the term umbrella company is used to cover all of the following offerings even though they operate very different business models:
- PAYE umbrella
- PEO – this term covers a type of UK payment model but is also used by US companies to describe an employer-of-record service across a number of different countries – they are different offerings although they're both involved in the engagement and payment of workers who work for end users (not the company that engages them)
- CIS umbrella – this is a misnomer because it is a company which purports to act as a Construction Industry Scheme (CIS) subcontractor and then pays construction contractors as sole traders under the CIS. This is not the same as a PAYE umbrella. A lot of end users are not aware that these are not full PAYE umbrellas – this has come to light in IR35 reviews in recent months. The use of the term "umbrella" in this context is misleading because it suggests that payments to contractors are subject to full PAYE and NICs and that ER's NICs are paid. The tax risk is that the agency worker tax rules will apply unless the sole traders are not subject to supervision, direction and control (SDC) – this could lead to a large tax assessment, which could make the umbrella or the top agency insolvent. This is a commercial risk for end users.
- Small umbrella companies – these have been in the news recently. They rely on using the NICs employment allowance and the VAT flat rate scheme, usually with offshore directors. HMRC has said that they are tax avoidance schemes.
- Umbrella with payment of tax free travel and subsistence expenses – these are unlawful in all but a small number of cases. Any umbrella contract that includes a clause stating that the employee is not supervised, directed or controlled (SDC) as to how they work (or words to that effect) should be challenged if this is not the case. Inclusion of such clauses is often a way for umbrellas to justify paying travel and subsistence expenses on a tax-free basis. Where workers are subject to SDC then payment of expenses will be unlawful and potentially fraudulent.
- Sole trader pay and bill arrangements – the tax risk is that the agency worker tax rules will apply unless the sole traders are not subject to SDC. This could lead to a large tax assessment, which could make the umbrella or the top agency insolvent. This is a commercial risk for end users.
- UK shop window for offshore employment/payroll schemes – an onshore staffing agency or its client could be liable for underpayment of tax and NICs.
It's not straightforward to define an umbrella company. But, given the growth in the use of gig workers and the opening up of geographical access to talent in new jurisdictions, there is a need for organisations to have a way of compliantly engaging and paying contingent workers.
This presents a huge opportunity for compliant umbrella companies and their role is set to expand, even if regulation is eventually introduced. Compliant and well-run umbrellas will have nothing to fear from this – in fact, they will welcome this development, especially if it stops tax avoidance schemes from operating and makes end users wary about using such schemes.
What does a 'good' umbrella or PEO look like, why do disreputable umbrellas exist and how do you spot them?
There has been a spotlight on umbrella companies recently and more regulation may be on the way, given the stories of dodgy tax schemes and worker exploitation. Regulation will be welcomed by reputable, compliant umbrellas. Unfortunately, there are offerings that appear to be umbrellas but are not. The challenge for staffing companies, end users and contractors is to understand the difference between compliant umbrellas which de-risk supply chains and those that don't.
Dodgy schemes seem to be present in all sectors and operate under a range of different guises, but generally, any arrangement that splits payments to workers or offers tax efficiencies should be avoided. These schemes have proliferated in sectors such as health and care and have resulted in some low-paid workers, including nurses and social workers, facing large tax bills under the loan scheme legislation. These schemes are largely misunderstood by the workers who sign up to them they often don't understand the complexities and sign up in the belief that the scheme is above board.
Such schemes exist because they offer their services to staffing companies and workers at lower rates compliant umbrellas can't compete with being undercut by these non-compliant schemes. There can also be an element of payments back from such schemes to staffing companies which are funded from the savings made.
Calls for regulation are understandable but there is already legislation in place which could be used to enforce against a lot of these schemes. It may be a case of HMRC more visibly enforcing legislation, such as legislation on failure to prevent the facilitation of tax evasion in the Criminal Finance Act, agency worker tax, legislation managed service company (MSC) legislation and offshore employer tax rules.
How can inheriting liabilities from dodgy umbrella companies be avoided?
There are many different legal risks in staffing supply chains but the main ones relate to tax status and underpayment of PAYE and NICs and to the misclassification or denial of employment status.
In some cases, such as IR35 and MSC, tax liability will transfer along supply chains and possibly to end users; in other cases, liability will transfer to the top staffing company or not transfer all but risk of damage to reputation by association could be significant. There is also commercial risk associated with suppliers which operate non-compliant schemes which could make them insolvent.
Agency workers and contractors have and will continue to bring employment status claims against end users. This risk can be reduced by using compliant, responsible umbrella employers who make it clear to workers who employ them and by ensuring that they receive their employment/worker rights such as holiday pay.
End users should carry out checks on their staffing supply chains to ensure (as far as they are aware) that they know:
- Who engages them? Are they PAYE agency temps engaged and paid by the staffing company or any they umbrella employees?
- Who pays them?
- Are the engager and the payer both onshore and registered at Companies House in the UK?
- At what rate are contingent workers paid? Is it roughly in line with what you would expect after factoring ER's NICs and statutory costs?
- Are no umbrella workers engaged via their PSCs (this would flag IR35 risk and concerns around MSC risk)?
- Do staffing suppliers and umbrellas have a decent trading record and up-to-date accounts that stack up?
Staffing companies should carry out the same checks and will, in any event, need to collect all of the above information for the purposes producing key information documents (KIDs) for each worker. A lot of the information will need to come from umbrella companies staffing agencies should have no problem getting this information from compliant umbrella companies. An annual (at least) refreshment of checks, periodic spot checks and requests to see redacted payslips are recommended.
Anything that doesn't look right should be looked into, including payslips that contractors want inspected. Sometimes the sample payslip the umbrella provides is not the same as the actual payslip received by the contractor, and they have been known to reveal payment by loans, split payments, expenses that don't exist or payment by another legal entity entirely, and the list could go on.
Where are umbrella and PEOs going?
Compliant, reputable umbrellas and PEOs will thrive and play a crucial part in helping organisations harness the benefits and flexibility of contingent workforces. Stamping out dodgy schemes will not be straightforward and will take time. Legislation mandating supply chain due diligence and exposing staffing suppliers and end users to liability for non-compliance would go a long way to achieve a move away from dodgy schemes. This is effectively what Parliament did with IR35 driving compliance from the top has been highly effective in addressing concerns around IR35 liability.
What employer costs need to be factored into the supply chain, how does this work in relation to umbrella contractors, and who is legally responsible for what?
Understanding statutory ""employment"" costs and identifying who is legally responsible for paying them is important for identifying the overall cost of supply, who is legally responsible for paying these costs, and ensuring that the cost of supply is not confused with the rate at which the agency worker or umbrella employee will be paid.
In a simple supply chain involving the end user, staffing agency and umbrella the rate charged by the staffing agency to the end user needs to be enough to cover the cost of supply based on:
- the cost of ER's NICs (headline rate of 13.8% or actual cost? The latter is difficult to know in advance and therefore actual costs is usually dealt with by way of adjustment);
- holiday pay, which is typically calculated at a rate of 12.07% of whatever pay is likely to be, although the decision in Harpur Trust v Brazel (see below) may affect this calculation;
- pensions auto enrolment employer contribution at 3% of gross pay; and
- the Apprenticeship Levy, which is 0.5% of gross pay.
This rate charged should also cover the staffing agency's margin. The umbrella cost is also usually deducted from the amount paid by staffing agency to the umbrella but this is rarely factored in as a cost KIDs may change transparency around this.
Also, in this example, neither the end user nor the staffing agency is legally responsible for these employment costs. The costs are relevant only to calculating how much the staffing agency must charge the end user. It is the umbrella who is responsible for calculating and paying the actual employment costs. But, the invoice from the umbrella company to the staffing agency rarely includes a breakdown of the employment costs.
Most umbrella companies pay their employees at a contractual rate of the NMW and then pay a bonus to top up the rate this allows for variations in employer costs to be factored in and paid for. The employer cost which, perhaps, causes the most confusion amongst contractors is the cost of ER's NICs. If a staffing agency consultant has quoted the rate it will pay the umbrella company rather than the rate the umbrella company will pay the contractor, then the contractor will be under the impression that they are funding their own ER's NICs. It's unlawful for a worker to have ER's NICs paid for out of money that is due to them and so it's important for staffing agencies and umbrellas to work together to ensure that the worker is not quoted the wrong rate.
KIDs have been introduced to try to tackle this problem but it remains an issue, especially with large numbers of PSC contractors having recently moved to umbrella. They have been used to being quoted a gross tax rate and a move to a much lower umbrella rate looks unattractive ‚Äì which, possibly, explains the interest and uptake of tax avoidance alternatives.
How and when do Conduct Regulations apply to umbrella companies?
Umbrella companies are ""employment businesses"" as defined under the Employment Agencies Act but in most cases they're not in the business of offering or providing ""work finding"" services and so they are not regulated as such under the Conduct Regulations. Arguably, they are limited company work-seekers and so can opt out of the regulations together with the individual worker provided the work seeker is not classed as vulnerable.
The new KID requirements are in section 13A of the Conduct Regulations. These require employment businesses to give work seekers a KID before they agree terms. In practice (and confirmed by government guidance), it is the staffing agency that must provide the KID not the umbrella company. However, it's likely the umbrellas will need to provide information to the staffing agencies to help them confirm details of pay and deductions, etc. The Conduct Regulations opt out, at section 32(9), does not apply to or disapply section 13A, so staffing agencies should give KIDs to all umbrella company work seekers regardless of whether they are opted out or not.
What are the implications for holiday pay do you anticipate any implications in recent case law with the Harper Brazel appeal?
In Harpur Trust v Brazel, a 2019 Court of Appeal decision on holiday rights for a worker, who worked for part of the year but on a permanent contract, may have repercussions for many umbrella companies who employ workers and contractors on overarching contracts of employment.
The Court of Appeal found that the WTR does not support a pro rata approach taken to accrual of annual leave, meaning that ""part year"" zero-hour employees on permanent contracts are still be entitled to 5.6 weeks' annual leave, and this entitlement cannot be prorated to take account of periods in the year when no work was done. This case is being appealed to the Supreme Court in November so, until then, it's likely that umbrellas will continue to accrue holiday (and holiday pay) based on hours worked.
This Insight is based on the content of the webinar on umbrella employees and agency workers and co-hosted by Osborne Clarke's Workforce Solutions group with giant on 29 June 2021. A full recording of the webinar is available on demand now."