Umbrella companies have become a popular option for many freelancers in the UK. Essentially, these are companies that manage the earnings of freelancers. They collect payment from the client or recruitment agency, handle necessary tax and national insurance deductions, and then pay the freelancer their due wages.
However, this sector remains largely unregulated, which has caught the eye of experts and government officials alike.
The Good, the Bad, and the Ugly of Umbrella Companies
Like in any industry, there are those who operate within the rules and those who seek to exploit them. Many umbrella companies provide legitimate services, ensuring freelancers receive the correct pay and benefits. Unfortunately, there’s a darker side too.
Some unscrupulous umbrella companies have been accused of withholding holiday pay from workers, unfairly taking money from pay packets, or even promoting tax avoidance schemes either for the worker’s perceived benefit or purely for the umbrella company’s own gain.
A concerning report by PayePass, a specialist in umbrella company compliance, revealed that the number of individuals working under these unchecked arrangements rose from 600,000 in 2018-19 to a whopping 700,000 in 2021-22.
Julia Kermode, who helms PayePass, has expressed concern, noting that unless the sector is rightly regulated, the trend could lead to an increasing number of people being lured into tax avoidance setups.
Changes in Tax Rules and Their Impact
April 2021 marked a significant shift in the way freelancers were categorized for tax reasons. A new rule emerged, determining whether a contractor is classified as self-employed (often referred to as “outside IR35”) or as an employed individual. Interestingly, this rule was already in place in the public sector since 2017.
But there’s a twist. After the rule change, employers began mandating that freelancers make use of umbrella companies. While this seemed like a straightforward requirement, it inadvertently opened the door for dishonest operators to exploit the system. Julia Kermode highlighted an alarming consequence: many freelancers discovered they had been ensnared in tax avoidance schemes only after receiving substantial, unexpected tax bills from HM Revenue & Customs (HMRC).
Government’s Response: A Call for Regulation
While it’s clear that there’s an issue, the wheels of government often turn slowly. As early as 2018, there were calls to regulate umbrella companies, following a detailed review into modern working practices. Fast forward to the present, and the government is still in the phase of gathering feedback and considering its next steps.
In defence of HMRC, they’ve stated that only a small number of these avoidance scheme promoters remain active. They’ve made strides in identifying and publicising promoters, directors, and schemes that don’t adhere to tax rules. Between August 2022 and August 2023, HMRC even issued 15 stop notices, explicitly ordering certain promoters to cease marketing their tax avoidance schemes.
While the government acknowledges the potential risks posed by some umbrella companies, they also note that many do comply with tax laws. Their stance is that they’re committed to acting against those who misuse the system.
Industry Voices Call for More
Despite the government’s reassurances, industry experts believe more aggressive action is necessary. Crawford Temple, CEO of Professional Passport, voiced concerns about the rising levels of tax avoidance schemes. He believes that the HMRC’s approach is not stringent enough, claiming that they’re pursuing the victims more than the actual culprits.
One of the potential solutions from the government’s consultation is to mandate recruiters or their clients to thoroughly vet umbrella companies. Failing to do this due diligence would result in penalties. Another suggested remedy involves transferring unpaid taxes from a non-compliant umbrella company to another entity within the labour supply chain.
Conclusion: The Path Forward
The increasing reliance on umbrella companies, combined with a lack of regulation, has created a perfect storm for tax avoidance schemes. As the government deliberates on potential measures, it’s crucial for freelancers and employers alike to remain vigilant and informed. While umbrella companies can provide valuable services, it’s essential to recognise the potential risks and ensure that everyone is playing by the rules.