Are users of umbrellas right to be concerned?
Clearly many lawyers will be trying to work out whether the amendment to the legislation does in fact have this, possibly unintended, consequence. The position is complex and the legislation is unclear in some respects. But there does seem to be a strong risk that users of contingent workers paid via gross-pay intermediaries (some of which will be divisions of umbrella companies) and CIS intermediaries will be subject to IR35 and its tax debt transfer regime.
This does NOT affect all umbrella models
At first sight, the problem seems only to apply to the extent that the payment intermediary does not deduct PAYE and NICs – and instead pays the contingent workers gross or without full deduction of tax/NICs. This "gross pay" model is used in industries such as construction with CIS subcontractors. It is believed also to happen with some more senior technical workers who might be inside IR35 (which is a broad test, with end users creating problems with cautious status determinations), but who can be shown to pass the narrower "SDC" test (which requires no supervision, direction or control as to how the work is done, and no assessment process by the end user). The model may also be used for workers who are working from home, which may have become more common recently of course.
A key thing to note is that most "umbrella" workers are not paid on a gross pay basis. Recent news reports will therefore not apply to the bulk of traditional umbrella workers. However, the gross pay model's attractiveness may be growing as the new IR35 regime approaches because it potentially allows much of the tax efficiency of the "old" IR35 arrangements to be retained by contingent workers who are assessed as failing IR35 but pass the gross pay SDC test.
One of the problems is that the term "umbrella" company has no legal definition and, whilst traditionally it was regarded as describing PAYE employers, it as has been used in the staffing industry to cover a range of payment intermediary models, and it is clear that some umbrella companies do offer gross pay models.
What happens where "gross pay" intermediary arrangements are caught?
This final changes to the IR35 legislation mean a gross pay intermediary (such as a gross pay umbrella or a CIS labour supplier) would probably fall within the definition of "intermediary" for IR35 purposes. This means that whoever pays the intermediary would become the fee payer for IR35 purposes and, as such, responsible for deducting PAYE and NICs where the IR35 test is failed. In most cases this fee payer will be the staffing company.
In situations where a gross pay intermediary is in the supply chain and HMRC raises an assessment which is not paid in full (perhaps because the relevant intermediary or staffing company above it in the chain has to close down suddenly) then ultimately the end user or any MSP may be liable for the shortfall.
History suggests that this technical tax debt transfer liability for end users and MSPs would in fact be the most serious problem users of gross pay intermediaries will face. Even if there are technical arguments that the gross pay model has been used correctly and staffing companies are happy with those arguments, major end users and MSPs may just not want the bother of working out whether the gross-pay intermediary model is safe. They may instead impose a blanket ban on the use of gross-pay intermediaries by their staffing companies, as some have done already for various other perceived risky supply models. There's also a risk that umbrella companies who operate full employment PAYE and NICs may be tarred with the same brush and prevented from operating within the supply chain.
We do not believe these developments will mean that umbrellas will cease to exist, and this briefing suggests why that is the case. But all organisations who, as a response to IR35 or otherwise, have or plan to have umbrellas or other intermediaries in their supply chain, may need to consider how this amendment affects them. They may wish to consider carefully how they engage contingent workers and whether certain payment intermediary arrangements will create more problems than they solve.
And end users will need to check out how contingent workers will be engaged and paid after the new IR35 regime comes into force.
Why has the umbrella model become more popular recently?
It had been thought, and HMRC have consistently stated, that the IR35 legislation is not intended to apply to umbrella or other similar employment intermediaries that apply PAYE and NICs on the basis that the contingent worker is their employee. It had instead been assumed that the new IR35 regime would only apply where the contingent worker was operating via a personal service company or similar self-employed operating model ("PSC"), such that the entity that paid the PSC would have to apply PAYE and NICs if the PSC worker was 'inside' IR35; if it did not, the liability could pass up to the end user.
As such, many staffing companies and some end users (who were loathed to set up a payroll operation and keen to use a third party that could perform that role efficiently) have moved or are in the process of moving all their PSCs to umbrellas.
It also seems that the gross pay model's attractiveness may recently have been sold by umbrellas and others as a way of taking an arrangement out of IR35 whilst potentially allowing contractors to retain much of the tax efficiency of the "old" IR35 arrangements. However, this final amendment removes a large part of the rationale for using gross pay arrangements as an IR35 solution, and may force an about-turn for many staffing companies, with a rush for internal payroll solutions. It will also potentially have a big impact on the construction labour supply chain where CIS has been used as a way to place supplies outside IR35.
Are there any ways to continue using gross pay intermediaries without having to apply IR35 processes?
It is possible that if the legislation is indeed unintentionally faulty it will be amended. We understand that there will be meetings with HMRC in the next week or so to discuss this.
Failing that, some users of umbrella workers may choose to rely on historic HMRC assurances that it does not intend the new IR35 arrangements to apply to staffing companies and end users who use umbrellas. But, if the legislation does mean what is feared, HMRC will have to apply the law as it is drafted.
Some gross-pay umbrellas may try to set up a further intermediary in the chain between them and the staffing company, such that that intermediary becomes the "fee payer". This approach may be deemed ineffective if it falls foul of tax avoidance rules relating to "artificial or contrived arrangements" and in any event there may be some end users who become alarmed by the ever-lengthening supply chain between them and their contingent workers. However, this approach may be worth considering, especially if motivated entirely by the need to avoid an unintended consequence of the final amendment to IR35 and if HMRC formally admit that this consequence was unintended .
And generally users should only allow gross pay intermediaries where they are reasonably sure there is no supervision direction or control over how the worker works or the worker is a home worker who passes the general employment status tests. The model should not be used for borderline cases because tax debt liability can transfer under the intermediaries legislation to the top staffing company or MSP in the supply chain.
Are umbrella employers an important part of the future of work?
In the longer run we consider that there is a strong role to be played by employment intermediaries like umbrellas.
Predictions about the future of work broadly all agree that, alongside the related increase in remote working, there will be a continuing rise in contingent working arrangements in coming years, whether through gig platforms or more traditional routes. This seems to be a natural and inevitable consequence of digitalisation and, in part, the current pandemic. People are working remotely and unsupervised, much work is becoming more specialised and episodic, and technology increasingly allows projects to be measured and paid on an output basis such that supervision and "pay by the hour" models are not needed. This all points towards greater use of self-employed and other contingent working arrangements.
But Matthew Taylor and others have identified that gig workers operating on this basis do not find it easy to access various pension, medical expenses and other benefits or funding for training or access to various financial services. Not least they don't have somewhere to store their pot of holiday pay or handle sick pay. They are effectively a growing underclass. And so the employment law authorities are increasingly expecting platforms to treat gig workers as employees, which the platforms are just not geared up to do – they largely see themselves as technology-enabled introducers.
Alongside this, tax authorities around the world have identified that the rise in gig working will lead to a huge shortfall in tax revenues if self-employed models grow (employment taxes are still the main form of government income in most countries). They want someone to take responsibility for collecting taxes relating to gig workers.
All of which means there is a crying need for an industry of employment intermediaries who can act as regular employers of people who get work through platforms and other routes. There has been talk of these intermediaries perhaps operating like medieval guilds – becoming specialist career-long supporters of people with particular skills. Umbrellas seem well quipped to perform much of that sort of role.
And some consider that in the longer run, umbrellas and similar employment intermediaries will disintermediate traditional staffing companies. The thinking is that in many situations there is no need for the staffing company to be in the contract or payment chain: they should be paid for what they specialise in and most like doing – finding candidates – and not be exposed to the credit risk and regulatory issues of being an employment intermediary. The thinking then is that these employment leasing/payroll aspects should be given to, likely very large, specialist processing companies like umbrellas which would have a direct relationship with the end user, simplifying the supply chain and avoiding problems in countries like Germany with chain leasing laws.
Alternatively, some umbrellas may merely licence their (in many cases highly efficient) payroll and related software and systems to staffing companies so that the staffing companies can in fact "do it" themselves. This will take a bit of setting up and will require consideration of Payment Services Regulations compliance issues, but many will see this as a logical and desirable evolution of the umbrella business model.
What checks should you in any event do on umbrellas and other intermediaries ?
Even if this blows over, all involved in the use of umbrella workers should be aware that HMRC expect them to carry out checks on their umbrella providers. Good quality umbrella companies will be happy to co-operate with this.
For those who are using the gross-pay model, everyone in the supply chain will need to be satisfied that it can be shown that there is no supervision direction or control as to how the work is done or that the home-working regime (which involves more traditional employment tests) is satisfied.
And the IR35 guidance issued last month makes clear that end users and MSPs must carry out checks on their supply chain in order to prevent the IR35 liability passing up to the end users and MSPs. HMRC expects them to establish the credibility and legitimacy of their supply chain.
This could include checking:
- What is the agency/labour supplier/umbrella’s history? (HMRC does not explain what this means but if there is evidence of historical problems with HMRC that may be relevant.)
- Is the agreed contract price for the supply of contractors lower than market value, without a clear explanation for why?
- Have normal commercial practices been adopted in negotiating prices? This might include unusual "referral fees" received by agency 1 or sharing of tax savings with end users.
- Is a newly established intermediary with minimal trading history offering to supply contractors cheaper than a long-established intermediary? Is this the same agency/labour supplier/umbrella as previous, but operating under a different name? If so, why?
- Is a supplier insisting that they can further subcontract the labour supply? If so, why?
HMRC says that suitable checks to secure the supply chain will vary depending on the circumstances and length of supply chains. Each organisation should consider what checks are suitable in their individual circumstances and be clear about things like referral fee policies.
On top of this, where umbrellas are used on any systematic or preferred supplier basis (or even if a material number of contingent workers happen to come through a particular umbrella) the Criminal Finances Act 2017 effectively requires the end user and relevant MSPs and staffing companies to have in place reasonable procedures to ensure the umbrella is not involved in any tax evasion.
Government finances dictate that eradicating tax avoidance will be high on HMRC's agenda for years to come. Annual audits and due diligence exercises (at fundraising or during M&A) will focus on your potentially huge tax debt transfer liabilities in this area. You therefore need to make sure that you are not storing up problems Users and suppliers of contingent workers need to take action to avoid these problems.
We have provided workshops on IR35 and the alternative engagement models to over 200 clients in the least two years. These involve analysis of all sorts of payment mechanisms including the gross-pay umbrella model. Please let us know if you would like such a workshop to help identify the best approach for you to IR35.