Umbrella companies consultation: tax aspects

The government has published a consultation on measures to address non-compliance in the umbrella company market. As well as setting out options for regulating umbrella companies, the consultation also considers a number of proposals in relation to tax non-compliance, including potentially transferring any unpaid tax liabilities to other parties in the supply chain.

Background

In 2021, the government published a Call for Evidence on the use of umbrella companies in the employment market and in particular the tax risks that they pose. The aim of the call for evidence was to gather further information about the role that umbrella companies play in the jobs market and what risks, both to workers and to government revenues, umbrella company structures pose.

Umbrella companies in this context are companies that typically employ a worker and provide payroll services for that worker, but do little more than that. A typical arrangement involving an umbrella company would involve an employment bureau finding work for a worker with a client. However, the worker would be engaged under an employment contract with a separate umbrella company with the employment bureau entering into arrangements with the umbrella company to on-pay monies received from the client to the umbrella company (less the employment bureau fee). As such, the monies for the services of the worker will pass from client through the employment bureau to the umbrella company before being paid as salary to the worker (less fees at each stage).

The Call for Evidence noted a number of potential advantages of using umbrella company arrangements:

• Workers who work on a number of short term contracts may maintain continuity of employment with the single umbrella company. However, equally there is evidence that workers may consider that they have little choice but to provide their services through an umbrella company arrangement as some employment businesses and clients will only use such arrangements.
• End clients do not have the administrative burden of employing workers directly.
• Employment businesses equally can simplify their administrative operations by using umbrella companies. Although, as an alternative, an employment bureau could use the services of a payroll company, the ultimate responsibility for operating PAYE etc would still reside with the employment bureau. By using an umbrella company, that responsibility is shifted to the umbrella company.
• Using an umbrella company arrangement means that an employment business is not required to treat workers as their own employee for tax purposes.

Response to the Call for Evidence

The new consultation reports on the response to the Call for Evidence. Responses from workers generally outlined the disadvantages of being employed by an umbrella company model, with lack of general understanding and concern over non-compliance. Many workers reported have little choice but to work through an umbrella company and limited choice over which umbrella company to use. Employment businesses recognised the issues faced by workers and the compliance risks, but outlined the perceived benefits of administrative ease and avoiding the need to operate a payroll for the workers they placed. End clients also tended to highlight the administrative benefits of using umbrella companies.

The Call for Evidence made it clear that the government was concerned that that the use of umbrella companies posed tax risks. One of the key areas for concern for the government was that umbrella company structures are often used to facilitate the use of tax avoidance structures, such as disguised remuneration schemes.

Another concern for the government was the use of what it termed mini umbrella company fraud. This involves the disaggregation of a larger umbrella company workforce into a large number of smaller umbrella companies, each typically employment a few employees. This is done in order to claim tax reliefs aimed at smaller businesses such as the employment allowance (providing relief from NICs) and the VAT flat rate scheme (allowing for VAT to be calculated as a fixed rate on turnover).

Beyond facilitating tax avoidance, the government is also concerned that umbrella companies simply facilitate fraud. A payroll intermediary such as an umbrella company may tax the required payroll deductions of income tax and NICs and simply fail to declare them and disappear.

The government notes that, since the Call for Evidence, it has taken action to address issues in the umbrella company market, including publishing further guidance and using compliance powers. However, a number of respondents had called for umbrella companies to be made illegal. However, despite the non-compliance, the government has decided that the evidence available does not suggest that an outright ban would be a proportionate response at this point. Instead, the government proposes to introduce additional measures to improve the operation of the market, including regulation of the market as well as addressing certain tax risks.

Tackling tax non-compliance

In relation to tax non-compliance, the consultation invites views on options to change tax obligations and HMRC powers to encourage a change of behaviour by businesses who use temporary labour and to disincentivise the use of non-compliant umbrella companies.

Businesses are currently able to outsource their employment tax responsibilities to umbrella companies with limited repercussions if they contract with an umbrella company that does not, in turn, fulfil these responsibilities. The government proposes two options to encourage organisations to undertake greater due diligence when deciding which umbrella companies to contract with.

Mandating due diligence

The first involves mandating businesses through a statutory obligation to carry out a minimum level of due diligence on umbrella companies that they use, with a potential penalty for failure to do so. The consultation recognises that the statutory obligation would necessarily be broad and would need to be supplemented by HMRC guidance as to what businesses would be expected to do in practice.

Transferring tax debts

The second option involves transferring a tax debt (PAYE and NICs) that cannot be collected from an umbrella company to another party in the supply chain. The government is also interested in considering whether this might be expanded to cover VAT in addition. By creating a potential consequence for labour supply chain intermediaries and users of temporary labour of engaging a worker via a non-compliant umbrella company, the government hopes that these businesses will be encouraged to take greater care when selecting the umbrella companies with which they contract. It could address the incentive that supply chain businesses currently have to effectively outsource their payroll responsibilities to umbrella companies, by introducing a potential liability in the event that the umbrella company does not comply with its obligations.

The government’s initial view is that it would be most appropriate in the first instance to seek to recover the tax debt from the employment business which supplies the worker to the end client. This is because this employment business is well-positioned in the labour supply chain to have oversight and control of the other parties who will enter the contractual chain. In the event that there is no employment business, or that there is no realistic prospect of recovering from the employment business, the government is interested in exploring whether it could also be appropriate to transfer the tax debt to the end client, which benefits from the supply of labour.

The consultation recognises that this option may not be appropriate in all circumstances and that it may be necessary to put in place safeguards to protect businesses which can show that they have taken reasonable steps to assure their supply chains. Possible safeguards could include not permitting a transfer to a business if it can show that it has exercised due diligence in deciding to contract with a particular umbrella company. Additionally, a safeguard could limit transferable tax debts to those arising from certain non-compliant activities, ensuring that genuine business failures are not included.

Moving the liability to the employment business

The consultation also proposes a third option, which would ensure that the liability for withholding and paying employment taxes to HMRC ultimately rests with the employment business, even where another company is engaged to operate a payroll on that business’s behalf. Some respondents to the Call for Evidence suggested that an effective way to prevent non-compliance by umbrella companies would be to prevent them from handling gross funds. This could be achieved by requiring a party sitting above the umbrella company in the labour supply chain (such as the employment business) to make deductions of Income Tax and NICs from the fee paid for the supply of the worker’s services. This would mean for example that non-compliant umbrella companies would not be able to incorrectly treat payments to workers as non-taxable, if the tax had already been withheld and paid to HMRC.

This option would involve legislating to change the entity in the labour supply chain that would be treated as the employer for tax purposes and secondary contributor for NICs purposes. This deemed employer would be responsible for deductions of income tax and NICs and also for payment of employer NICs.

Targeted action on VAT and employment allowance

In addition, the consultation seeks views on changes to the employment allowance and the VAT flat rate scheme, both of which are abused by so-called mini umbrella companies. These mini umbrella companies fraudulently exploit the employment allowance via disaggregation by ensuring the company’s employer NICs liabilities for the year are covered by the £5,000 relief meaning no employer NICs is paid. The same entities deliberately misuse the flat rate scheme to exploit the lower flat VAT rates available, often by relying on an incorrect trade classification

As regards the VAT flat rate scheme, the government is seeking views on whether it continues to offer administrative benefits given the introduction of Making Tax Digital. As regards the employment allowance, the government proposes to introduce a requirement that a UK resident director be in place in order for company to be eligible to claim the allowance. At present, the success of the mini umbrella company abuse model is in part attributable to the UK director being replaced by an offshore director. This makes it harder for HMRC to recover debts or seize assets from individuals in overseas territories.

Comment

The consultation is open for responses until 29 August 2023 which should be sent to umbrellacompanyevidence@hmtreasury.gov.uk