UK draft 'umbrella' company tax legislation gives staffing supply chains 8 months to prepare for change

The government has published draft "umbrella" tax legislation that will form a new chapter of part 2 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) from April 2026.

New umbrella tax regime: main features

Staffing companies, or "agencies", and end clients that engage workers via umbrella companies or other employment intermediaries, such as employers of record (EOR), will be liable for any failures by those intermediaries to account properly for Pay As You Earn (PAYE) and National Insurance Contributions (NICs).

The agency that holds the contract with the end client will be the 'relevant party' that is jointly and severally liable with the "umbrella company". This means that managed service providers (MSPs) will be liable where the services of an umbrella worker who has been engaged via a second-tier supplier is "on-supplied" by the MSP to an end client. 

There will be no statutory defence. For example, liability will not be avoided by being able to show that you carried out checks on the umbrella or were deceived by the umbrella or only used accredited umbrellas.

This may all lead to substantial changes in how many labour supply chains are structured, and how payments are made in those supply chains. Many end clients, MSPs, agencies and umbrella companies will need to make big decisions, fairly quickly, about how they will operate from April. This Insight sets out some of the options they may look at.

Tackling tax non-compliance

Tax non-compliance by certain umbrella companies is seen as one of the biggest risks within UK labour supply chains. The last government consulted on a number of options to tackle the issue, including the option to introduce mandatory due diligence into umbrella company operations for agencies using their services. That approach has not been followed and a more swingeing regime is proposed.

Employer's reference number not changing

Umbrella companies will still be able to hold the employer's reference number which means that umbrella companies will still be able to pay workers through their own PAYE payrolls.

But what is changing?

The agency that has the contract with the end client – known as the "top agency", – or the end client where there is no agency between the end client and the umbrella company, will be jointly and severally liable with the umbrella company for PAYE and NICs due in respect of payments to umbrella workers. This means that if there is a default on any payments to HMRC in respect of umbrella workers, HMRC can seek recovery from the umbrella or the top agency or (if there is one) the MSP or (if there is no agency), the end client.

Failure to account for PAYE and NICs will be a strict liability offence with no statutory excuse. In other words, the top agency (or end client, as appropriate) will be liable, regardless of whether it was at fault or had any intention of wrongdoing. Even where the top agency or, as appropriate, the end client has undertaken all reasonable tax compliance checks, they will still be liable if the umbrella company fails to meet its obligations.

This will also be the case where an intermediary that appears to be an umbrella company says that it will pay workers via its PAYE payroll but then pays them via personal service companies (PSCs) or without deduction of PAYE and NICs.

Relying on industry accreditation and compliance checking services will provide no defence to liability under this new law. 

Impact on MSP arrangements with second-tier agencies

MSPs may find the impact of this new legislation particularly challenging and there may be changes in MSP models aimed at taking them or second-tier suppliers out of the labour supply chain altogether, leaving them merely with a supervisory or introduction-only role. MSPs may require second-tier supplier agencies to pay all agency workers via their own PAYE payroll. In some cases agencies which are dependent on various types of umbrella support may end up being forced off second-tier preferred supplier lists with MSPs filling an increasing proportion of vacancies themselves.

Alternatively, it may lead to those agencies looking to reframe how they are supported by the umbrellas, perhaps with the umbrellas becoming Financial Conduct Authority authorised payroll agents that are no longer holding the worker contract but dealing with all aspects of payment. This would seem a logical place in the supply chain for more sophisticated umbrellas to take in the future: - in other words, continuing to administer payroll but no longer acting as 'umbrella companies'.

End clients

Where there is no agency in the labour supply chain and the "umbrella company" has a contract directly with the client hiring the worker's services, it is the end client that will be jointly and severally liable for any default by the 'umbrella company' to account to HMRC for PAYE and NICs due.

End clients, therefore, need to carry out due diligence on all "umbrella companies'"(as defined) with which they engage, in the same way as agencies. "Umbrella companies2 will include not only those companies that market themselves as umbrella companies but also other employment intermediaries such as EORs. They may also, in some cases, need to apply those due diligence measures to consultancies who supply them with staff.

Anti-avoidance provisions?

Except for the "purported umbrella" provisions – which address specific types of avoidance, such as where, instead of paying workers subject to PAYE and NICs, the 'purported' umbrella pays workers gross through individual PSCs or small umbrella companies – there are no anti-avoidance provisions.

The risk in any supply chain is that an unscrupulous end user in pursuit of a low-cost supplier will engage a top agency that is willing to engage a 'here today, gone tomorrow' intermediary that folds as soon as they come under HMRC's scrutiny. Given current economic pressures on businesses to reduce labour costs we will not be surprised to see some staffing companies continue to offer implausibly cheap labour and some end clients prepared to turn a blind eye to the likelihood of tax avoidance. There are no anti-avoidance provisions targeting this sort of behaviour by end clients, However, in the more extreme cases, HMRC would have other powers including under criminal law against organisations which adopt this approach.

Which workers are caught by the regime?

The government has adopted an extremely wide definition of umbrella worker, being any person whose services are supplied via an intermediary that employs them or purports to employ them.

EoRs will be caught. The following will also be caught:

• Secondment arrangements by government departments .
• Some consultancy arrangements.
• Time and materials consultancy arrangements in which benched employees of the consultancy work for an end client.
• Some hire, train to deploy arrangements.

The following will not be caught:

• Contractors who provide their services through their personal service companies (PSCs) – IR35 will continue to apply to them provided they are not part of a 'purported umbrella' arrangement.
• Traditional agency workers who are engaged by the agency under a contract for services and are paid via the agency's PAYE payroll. The agency-worker tax regime will still apply., The agency worker tax regime deems the top agency as employer for tax purposes in the same way that the new umbrella tax regime will do and so trying to continue tax non-compliance via the traditional agency worker (rather than umbrella worker) regime will offer no advantage from a tax planning perspective
• Construction Industry Scheme (CIS) subcontractors who engage via so-called CIS umbrella companies are not caught by the new legislation. The agency worker tax regime will however continue to apply to these arrangements where a CIS worker works subject to supervision, direction or control (which, in practice, many may do).

Employment Rights Bill interplay?

It appears that the two regimes may not be very well "joined-up", which will be regrettable – it will add to the administrative burden of end clients and agencies if the parallel initiatives end up meaning workers are umbrella workers for the purposes of employment legislation but not tax legislation or vice versa. 

Continued need for staffing supply-chain due diligence

While staffing companies may think that with accountability for umbrella PAYE and NICs being automatic and unconditional, there is little use carrying out umbrella company due-diligence checks, good checks will of course reduce practical risk. Also it is important to remember that liability for umbrella company PAYE and NICs is not the only reason to carry out checks on the umbrella companies that agencies engage with.

Liability to tax under the umbrella legislation will be a civil not criminal matter, but end clients and agencies also need to ensure that they carry out reasonable due-diligence checks to ensure that they are not committing the corporate criminal offence of failing to use reasonable procedures to prevent the facilitation of tax evasion.

What about the accreditations and insurance?

New accreditation platforms are emerging, which are capable of carrying out, in real time, checks into umbrella companies' tax treatment of umbrella workers' employment income and the corresponding payments of all sums due to HMRC to help satisfy agencies and end clients using their services of their compliance with applicable legislation.

The accreditation may also be backed up by an insurance policy that the umbrella will pay for, but which will pay out to the agency or end client (whichever has the contract with the umbrella) in the event of default. Some will regard this as preferable to an indemnity, which will only be as good as the umbrella is financially sound or able to meet the liability.

Those supplying and using the services of umbrella workers will likely want to make inquiries of their suppliers as soon as possible to understand which industry accreditations and insurances they hold or are working towards holding in the near future.

No due diligence or accreditation tool will be perfect and users of umbrella company services may need to put their own additional measures in place – but the ability to check an umbrella company's activities in real time and online is potentially a game changer.

Anyone relying on these accreditations will also need to consider whether they also provide a reasonable procedures defence for Criminal Finances Act purposes, and all will need to ensure that the information flows those tools will involve, do not breach General Data Protection Regulation. As already mentioned, insurance products are bound to be looked at as part of all this. With insurance, the key is to check the fine print: will it in fact provide enough cover and for the right things, and what procedures will be needed to ensure it applies and does not create further tax risk under the managed service company tax regime in chapter 9 of part 2 of ITEPA (which can be triggered by certain types of tax indemnification)?

Next stage

The draft legislation still needs to go through further parliamentary stages and receive Royal Assent before it becomes law in April 2026, as part of the Finance Act 2025-2026, but now is the time to start exploring the effect this change could have on your labour supply chains. 

The draft legislation is open for technical consultation until 15 September and anyone with questions or comments on the legislation can send them to umbrellacompanyevidence@hmtreasury.gov.uk.

Osborne Clarke comment

What labour supply models will we end up with?

Many UK staffing supply chains rely on the use of umbrella companies, to a greater or lesser extent. All involved will want to understand how, when and to what extent the new legislation will apply and will need to start thinking about what changes need to be implemented before April 2026 – eight months is not much time to restructure engagement and payment models.

More sophisticated and well-established umbrellas should be able to set up processes that are transparent, in terms of how they pay workers in a way that agencies and end clients can have confidence in. We understand that some have already worked hard on that, in anticipation of this new regime, and some may come up with innovative approaches to supporting the supply chain. We would be surprised if they suffer a significant loss of business, provided they get those systems right.

There may be other cases where MSPs look hard at the risk they are prepared to carry in their supply chain, seek to consolidate supplier lists and choose not to use agencies who rely on certain types, or any type, of umbrella. Staffing companies affected by this, and not able to run their own payroll, will need another way of working and may look to use umbrella companies solely as payroll administrators or payroll agents, or the like.

Staffing supply chains that rely on certain types of umbrellas to provide cashflow funding (under which the umbrella pays the workers before being paid by the agency or end client) may need to find other sources of funding, with invoice discounting arrangements likely to be part of the solution for many. However, query whether asset-based lenders will want to lend to agencies and MSPs if they are to become jointly and severally liable for umbrella company tax compliance? 

Staffing companies (and end clients), who have hitherto benefited from implausibly cheap labour supplies from certain umbrellas in sub-sectors such as healthcare and logistics, may, if they don't want to be landed with large tax bills, find their staff costs going up significantly. Some may no longer be able to operate competitively in their chosen markets.

Many end clients, MSPs, staffing companies and more sophisticated umbrellas will be tempted to push for a wholesale migration of workers from no-longer-wanted umbrellas to other arrangements (whether to "good" umbrellas or in-house payroll). Care will need to be taken to ensure that certain accrued liabilities do not pass over with the workers in any attempted forced migration. Undoing "risky" legacy arrangements may not be straightforward because case law suggests that if umbrella workers are treated as chattels to be moved around at the whim of agencies or end clients then they were never "really" employees of the umbrella company and were "really" employed by the agency or end client. If so, this would raise some complex questions around who is liable as the employer.

Introduction of laws that further restrict the use of umbrella companies may lead to renewed interest in self-employed models and personal service company contracting. The growth in use of umbrella workers followed the 2017 and 2021 IR35 changes (which made personal service company arrangements less attractive to many end clients and agencies).

Will the new umbrella tax regime see a movement back towards the use of PSCs? Unlike the umbrella tax regime, the IR35 regime has an element of statutory defence for end clients where appropriate "status determination statement" processes have been gone through or for end clients or agencies where fraudulent documents have been provided up the supply chain.

We suspect a lot will depend on whether we see any high-profile IR35 assessments raised by HMRC in the next 12 months or so. Where apparent lack of enforcement is evident, this may lead some to believe that use of PSCs is a lower-risk option. This, together with the recent employers' NICs rise, the new umbrella tax laws and the proposed guaranteed hours rights for agency workers may lead to a growth in PSC usage in some sub-sectors. 

In the construction sector we may see a move away from PAYE umbrellas towards self-employed CIS subcontracting arrangements. Where this approach is taken, agencies and MSPs continue to need to ensure that CIS contractors work without supervision, direction or control or risk becoming deemed employer for tax purposes.

In relation to this possible increase in use of self-employed models we expect there will be renewed interest in structuring supplies as so-called statement of work or provision of output-based services (rather than staff supply on a time and materials basis).