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The Transition to Umbrella Companies
For organisations that either made a strategic decision to remove Personal Service Companies (PSCs) from their supply chain, or status assessed contractors to be ‘inside IR35’, a popular transition plan for some was to engage that resource via umbrella companies on or after 6 April 2021.
Whilst umbrella companies are not new arrangements, pre 6 April 2021 their use was perhaps less widespread due to the perceived advantages to contractors of operating via PSCs. We continue to receive a variety of questions from end clients on how they can best ensure their supply chain is compliant and aimed at better understanding how umbrella companies operate. The motivation for doing this is to ensure compliance with the IR35 requirements and to do everything possible so that their off-payroll workforce receives fair pay and entitlements as required by law. This article aims to share market experience from working with clients who use temporary labour via umbrella companies within their supply chain and provides more insight on how umbrella companies operate.
What is an umbrella company?
Whilst there is no statutory definition of umbrella companies and they can operate in different ways, they are primarily intermediaries which either employ or engage (e.g. via an agency worker contract) individual workers who provide services for a number of different end clients (broadly the client that the worker ultimately ‘works for’ or is primarily controlled by) on typically short assignments.
The umbrella company’s function will typically to be to manage all timesheet administration with the contractor, billing arrangements with the end client and perform administration such as payroll compliance. As either the employer or ‘agency’ (depending on the engagement route), the umbrella would be responsible for compliance with law and regulations in the same way as any other employer or agency. This would include employment tax/payroll compliance, pension auto enrolment obligations and adherence with other employment law/worker rights entitlements such as holiday pay and National Minimum Wage.
Umbrella companies can in some cases also be referred to as ‘employment businesses’ (which should not be confused with employment businesses/agencies or recruitment businesses whose primarily role is to offer a market for identification and resourcing of temporary labour to their clients) or more recently ‘professional employment organisations’. We will use the expression umbrella company to mean any one of these vehicles for the purpose of this article.
Do Managed Service Providers and/or agencies use umbrella companies?
Many Managed Service Providers and/or employment agencies use umbrella company partners as part of their supply chain so as to be able to handle the administrative scale of their clients’ temporary labour needs. Compliant umbrella arrangements can therefore be one possible solution to handling the practical and administrative demands of a flexible temporary labour market. Some MSPs and agencies may alternatively offer to perform the payroll and statutory obligations without use of an umbrella company within the supply chain.
We would note there is still some nervousness from clients on the standard of compliance across the vast umbrella market. We are supporting clients in consulting with their MSP and/or agency in order to obtain sufficient diligence to provide them with reasonable confidence that any umbrella company in the supply chain is fully compliant.
Where do umbrella companies sit within a temporary labour supply chain?
There could be a wide range of supply chain structures per our illustration below. It will be important to understand which structure is relevant to your situation in view of taking any steps to mitigate potential risks (see below).
What could a contracting chain invloving umbrellas look like ?
What is the risk for end clients of using umbrella companies?
The recent government publication and media interest on ‘mini umbrella’ fraud is likely to be at the more serious end of non-compliance with the rules, but we have been made aware of other practices (more detail below) that can deprive contractors of their basic legal rights and entitlements when operating through umbrella arrangements.
By inadvertently operating through a supply chain arrangement with a non-compliant umbrella which deprives the worker of their full legal rights and entitlements, the primary and most damaging consequence to a responsible end client is likely to be reputational. It may be the case that the worker does not actually have any direct claims against the end client, either under statute or by virtue of the contracting structure in place. However, whether that is the case or not is likely to be a secondary consideration for a responsible employer primarily concerned with ensuring that their non-employee wider workforce receive the full pay and benefits they are entitled to.
Umbrella companies typically operate at low margins, where their gross profit for each worker assignment is the price paid by their client (which could be an MSP, agency or the business within which the worker will operate), less the total cost of employment (inclusive of gross fees, and other employment costs such as employer NIC and pension). To the extent that any of the employment costs can be reduced, the target profit per assignment can be increased, or at the very least preserved to balance other uncontrollable factors (e.g. levels of NIC varying by pay band, or due to late timesheets). We have been made aware that in some cases, umbrella companies may structure pay arrangements to reduce employment costs below the statutory requirement, but still present pay favourably to the worker. Entitlements under and compliance with rules relating to the following areas can in some cases be in point:
- Pension Auto Enrolment obligations;
- Holiday pay provision;
- Employer NIC operation;
- Coronavirus Job Retention Scheme;
- Travel and subsistence tax relief rules; and
- Artificial loan arrangements.
Some organisations offer umbrella company testing and this may be of some value, but we strongly recommend that independence diligence is undertaken on supply chain arrangements particularly given HMRC’s best practice guidance on this topic. Please click here and view Our Services to see how we can support you with such diligence services.
What does the external regulatory environment surrounding umbrella companies look like?
To date, there has been no focused regulatory scrutiny of umbrella companies, meaning the only enforcement threat against them is in cases where individual workers exercise their right of recourse by bringing claims in the employment tribunal against their paymasters. Umbrella companies have recently been referenced both in Matthew Taylor’s government-commissioned review of modern working practices, and, the government’s ‘Good Work Plan’ response to that review as follows:
- Matthew Taylor Review of Modern Working Practices (Excerpts):
- “We have heard from some who would like to see umbrella companies removed from the supply chain altogether. However, we do not believe this is a proportionate response to the issues faced. That said, while umbrella companies have played a legitimate role in higher skilled, higher paid sectors for years, at the lower paid, lower skilled end, their role is more questionable for a number of reasons.”
- “Employment rights therefore need to strike the right balance between security, flexibility and innovation. Above all though people need transparency, information and advice about what their rights and legal position may be in any particular context and relationship.” (LawWorks submission to the review).
The Taylor Review recommended that the new Director of Labour Market Enforcement should consider whether the remit of the Employment Agency Standards Inspectorate ought to be extended to cover policing umbrella companies and other intermediaries in the supply chain.
- Good Work Plan response (excerpt):
- The Government will introduce legislation to expand the remit of the Employment Agency Standards Inspectorate to cover umbrella companies. This will empower the Employment Agency Standards Inspectorate to investigate complaints involving an umbrella company and take enforcement action where required. This action will focus on situations where agency workers have not received adequate pay and will protect decent employers from unfair competition. We will continue to monitor the role of umbrella companies by ensuring the Employment Agency Standards Inspectorate work closely with HM Revenue and Customs and the Gangmasters and Labour Abuse Authority to identify any further enforcement or regulation required to tackle any detriment.
In June 2021, the government announced a variant of its Good Work Plan proposed enforcement response by signalling its intention to create a Single Enforcement Body to unify existing labour market enforcement bodies into ‘one brand’; this would take over the enforcement for areas that currently sit with HM Revenue and Customs, the Gangmasters and Labour Abuse Authority, and the Employment Agency Standards Inspectorate, as well as the enforcement of worker rights which are not currently enforced by a government body (such as Holiday Pay). Umbrella companies will fall under the remit of the Single Enforcement Body, although no current timeline of adoption has been communicated at the date of writing.
What should we do now to guard against risk of umbrella company non-compliance?
At the least we would encourage all responsible employers to fully understand their supply chain for temporary labour, including any umbrella companies. This would include working with direct Managed Service Providers (MSPs) and employment agencies to best guarantee compliance throughout the supply chain. We would also recommend that direct contracts with MSPs and employment agencies are updated to mandate supply chain compliance responsibility to them and incorporate as wide a protection as possible for any consequential future losses.
We strongly recommend independent diligence is performed on supply chain and umbrella company arrangements and we are supporting clients with this. Please click here and view Our Services to see how we can support you with such diligence.