The UK press has recently been full of stories about umbrella companies using dodgy tax schemes and otherwise exploiting workers, with calls for them to be banned or regulated. And MPs from different political parties are now suggesting law changes which could effectively lead to the end of umbrellas as we know them.
This focus seems to have been prompted partly by the flood of Personal Service Company contractors (PSCs) into umbrellas after public and private sector IR35 reforms, and partly by the pandemic-linked groundswell of opinion in many quarters in favour of fairer working conditions for gig workers.
Whatever some umbrella companies offer, or have offered in the past, we do not consider blanket prohibition is practicable or desirable, and this briefing explains why. But we do consider that some changes will happen and we know that the more well-established and legal risk-averse umbrella companies, some of whom are now attracting institutional investment, will welcome this.
This briefing maps out how the umbrella companies (and US-style professional employer organisations, or PEOs) are developing, how to use them safely, what legal changes are likely in order to help them perform a better role in the UK economy and beyond, and why they may end up becoming even more important players in the workforce solutions industry.
What exactly are umbrellas?
Use of umbrella worker models has grown in the UK in recent years. There has been a similar growth in the use of PEOs and Employer of Record companies in the USA. There are some differences between the UK and US models but they both essentially involve an entity engaging a worker (usually on an employed basis) and leasing or seconding the worker on to an end user (often via a staffing company in the UK umbrella model).
In theory therefore they simply engage individuals and second them out to clients. But who doesn't from time to time second employees out? Osborne Clarke regularly does, as do government departments, major consultancy businesses and technology businesses. The public sector is a particularly big user of seconded/"umbrella" workers. So the concept is long-established and widespread.
What are the good reasons for the survival and success of umbrellas?
Flexible workforce models are ever more popular, with many end clients trying to minimise their fixed employment costs by engaging contingent workforces (that is, individuals not engaged on a directly employed basis). Recent reports such as the Randstad survey this month suggest that the Covid-19 pandemic has led businesses to increasingly adopt a more flexible approach to talent (with 56% of businesses expecting to shift more of their roles to contingent, project or contract work according to Randstad). The better umbrellas have therefore invested in good payroll systems which work well for short term/temporary workers, and can access in some cases decent benefits at good rates for those workers (in a way that smaller staffing companies and end clients might not). Indeed the access to cost-effective benefits has been a key factor in the growth of the US PEO industry.
And so, when IR35 changes arrived in 2017-2021, with the complicated payroll calculations necessary for any contractor found to be "inside IR35" (which relatively few staffing companies and end users were well-placed to deal with), they seem to have swept up the market and taken over payrolling of former PSCs operating on those shorter term contracts which did not suit direct employment by the end user.
In addition there are signs that they, and PEO companies, have helped major companies payroll their increasingly globally-distributed workforces, with people often now based in countries in which the user businesses have no formal establishment.
Another opportunity area, as predicted in the Taylor Report, is that umbrellas may become the solution to the "gig workers have no rights" problem. We believe major online platforms will start looking to engage gig workers via umbrellas who can payroll and benefit the workers, making sure they build training, pension and holiday pay pots from gig to gig. One major platform has announced plans of this nature, and we know others have looked at this as an option.
So, why do "dodgy" umbrellas still exist?
Well, undoubtedly in the UK there has been some use of more or less aggressive tax planning arrangements from which all in the relevant supply chain benefited, and in some cases still benefit.
This started with use of tax-free expenses arrangements which became very popular in 2007 after the Managed Service Company legislation (sections 61A-I Income Tax (Earnings and Pensions) Act (ITEPA), and related provisions) ended "composite company" usage. These expenses arrangements significantly reduced the headline rate of tax and national insurance contributions (NICs) for umbrella workers.
That was followed by growing use of (often offshore-based) loan schemes, mini umbrella arrangements, VAT mitigation schemes and sole trader arrangements. At least some of the savings from these schemes were shared by umbrellas with the staffing companies and end users who used them, in the form of lower charges (than would otherwise have to apply) for the supply of the workers and/or in some cases "referral fee" arrangements which often involved passing back up the supply chain some of the tax savings (in some cases constituting secret margin arrangements for staffing companies operating on "fixed margin" deals with end clients).
How do some of the "dodgy" schemes operate?
We have explained how these schemes operate in previous briefings over the last 12 years - they are not new news.
The expenses schemes treated each assignment of an umbrella worker as being at a temporary workplace under the same overarching contract so that travel subsistence and accommodation expenses could be paid tax free. This could reduce the headline rate of tax and NICs for some umbrella workers by 15-30%.
The loan schemes effectively treat most income as a repayable loan not subject to income tax or NICs, the loan being in practice not repaid.
The mini umbrella schemes route each worker via a small umbrella company which falls under the NICs threshold allowing use of the "employment allowance" (meaning no employer's NICs are paid). These schemes also use and in some case still use the flat rate VAT scheme under which more VAT is charged to clients than is remitted to HMRC.
More recently commentators have focussed on the common practice of accruing holiday pay for umbrella workers but not actually paying out on termination of "employment" (because the workers forget they are entitled to it in many cases).
There are various other schemes that have come and in most cases gone.
PEOs have their own compliance issues – some have historically used split payment schemes (paying some income offshore) and others gloss over the corporation tax and VAT risks they expose their clients to.
Whackamole: what has been done so far to eradicate these schemes and is it working?
Most expenses arrangements were ended by section 339A of ITEPA (and related provisions) in 2016.
HMRC Spotlight 24 explained in 2015 how mini umbrella schemes would be attacked.
The loan charge was introduced to penalise users of loan schemes in 2016.
Perhaps most importantly from the perspective of end users and staffing companies the Criminal Finances Act (CFA) and so-called Enabling Legislation of 2017 gave HMRC the power to pursue entities in the supply chain above umbrellas using these tax evasion or tax avoidance schemes (with the potential for unlimited fines in the case of the CFA).
It is clear that many umbrellas have avoided, or at least do now avoid, use of these schemes but there is a sub-culture within the industry which still uses some or all of these schemes. Depressingly this includes alleged schemes for workers returning to the NHS to help with Covid-19 (HMRC Spotlight 54 identified in 2020 that many of them were paid using unlawful umbrella loan schemes) and for workers engaged to help with track and trace by G4S and the like (Private Eye and others have claimed that they are engaged via mini umbrella arrangements).
Many believe HMRC has not taken action quickly enough to suppress these schemes and as a result, in some industries, they have become so widespread that some end users and staffing companies have felt that, in order to keep prices as low as those of their competitors, they have to use them as well. We believe many feel they have no option other than to stick with these schemes or face business failure. It is alleged that some end clients don't care that their requirement for low prices effectively forces staffing companies to use these schemes.
What do you need to do to avoid inheriting liabilities from "dodgy" umbrella companies?
We advise regularly on this.
It is NOT enough under current UK legislation just to select ones that are members of trade associations or have some sort of audit certification: that is not enough to eradicate risk under legislation and there is no formally approved audit standard yet (though that may come). Certainly it helps to check the umbrella is approved by Professional Passport or the FCSA or the like, but all in the supply chain will still need to carry out regular spot checks on a random audit sample of payslips and BACS transmission sheets and RTI submissions to check that a credible after tax amount is being paid into a UK bank account in the name of the individual worker. This is the only way confidently to avoid liabilities for unlimited fines under the CFA and other liabilities under other tax avoidance legislation.
If you use a global PEO make sure you do equivalent spotchecks and in addition take advice about permanent establishment tax risk the model may in some cases expose you to. (Good PEOs may be able to help you with this).
Can the government ban umbrellas?
Not easily in our view.
As mentioned above, government departments, major consultancy businesses, law firms and technology businesses all regularly second employees, and many economists would argue that it a healthy thing for the UK economy for people from time to time to be assigned out to learn the ropes at client businesses. And a lot of staffing industry turnover involves "just" payrolling workers that the client or third parties refer to them – that valued activity is effectively employee leasing i.e. effectively umbrella activity.
Therefore it would be damaging to prohibit all employee leasing, and that seems to have been accepted by government policymakers we have spoken to in the past about this issue.
Perhaps a prohibition could be introduced just for businesses who "mainly" are in the business of employee leasing. But such a measure risks creating an easily exploitable loophole.
How might umbrellas be regulated?
Perhaps the easiest and best approach to the regulation of umbrella companies is to make end clients liable for all failures in their supply chain, especially relating to tax, holiday pay and National Minimum Wage (NMW). This is how similar issues are effectively dealt with in countries like the USA, Netherlands and Germany and is an approach which has been adopted in the UK with PSCs (that is, the recent changes to IR35). This would force end users to self-police their supply chains, and would avoid the need for a huge government inspectorate. Osborne Clarke spoke with Matthew Taylor about this when he carried out his review of these sorts of supply chain risk three years ago.
"Good" end users, staffing companies and umbrellas stand to gain from this – end users will buy on quality rather than mainly on price, and so suppliers of higher quality services will finally no longer be undercut by users and purveyors of dodgy schemes.
Possibly that chain liability measure will come with a defence for those who engage workers via umbrellas that have satisfied a new audit standard or obtained a licence akin to the Gangmaster & Labour Abuse Authority (GLAA) licence regime. Some commentators have predicted in fact that the GLAA regime will be extended to all labour supply companies (staffing and umbrella companies). We should add that we do not believe the labour supply industry will be appointed to self-police with self-designed standards.
Technical changes could be made to anti-avoidance legislation to capture mini-umbrella schemes more easily, and HMRC enforcement activity could become more vigorous. For example, at some stage a criminal prosecution of a large staffing company, Managed Service Provider or end hirer is possible under the CFA.
Combined with that we imagine that at some stage the payment out of accrued holiday pay will be made compulsory, with HMRC having similar enforcement powers to those it has for NMW.
Where will umbrellas and PEOs end up?
It is a fool who predicts too much in the modern world but it seems likely to us that, except in countries that decide that all flexible workforce models should be banned, umbrellas and PEOs (whether under those names or some new badge) will continue and thrive, but in a more regulated environment which slowly eradicates the "dodgy" players.
In fact it is not beyond the realms of possibility that, as the recruitment function for many types of role becomes automated using artificial intelligence and other systems, the umbrellas and PEOs will be become the technology-led recruitment partners for major corporates, helping them run, deploy and payroll their own banks of globally-distributed talent.
We believe that these trends will attract investment to these inherently cash-generative, technology-enabled and scaleable business and we would expect more to list or attract significant institutional investment in coming years, for which there is already a clear trend in the USA.