Umbrella companies and non-payroll workers in your labour supply chain, how strong is your due diligence?

Following some recent press coverage regarding umbrella companies, there has been a renewed attention on the use of these companies. This press coverage has followed the increase in prevalence of umbrella companies generally following the IR35 reforms which has seen a number of organisations switch to contracting with off-payroll workers through umbrella companies rather than engaging directly with the contractor’s Personal Service Company.

Significantly it has been accompanied by the release of HMRC of both guidance on Mini Umbrella Company (MUC) fraud and “advice on applying supply chain due diligence principles to assure your labour supply chains” which places responsibility for supply chain assurance on the end user. The supply chain assurance advice covers not only MUCs but all other forms of non-payroll worker, including IR35, the Construction Industry Scheme and Agency workers and therefore is far more wide ranging than the strict legal requirements under the IR35 rules.

However it is important to consider the MUC arrangements which appear to have triggered this response.

What is an umbrella company?

At a basic level an umbrella company is the legal employer of a worker providing their services to a client of the umbrella company.  The umbrella company as the employer must operate PAYE/NIC deductions and deal with related matters such as the Apprenticeship Levy and pension auto enrolment contributions.  It is important to note that in general umbrella companies operate within the letter and spirit of the law and are not part of the MUC arrangements which are giving cause for concern in the press and within HMRC.

What are the areas of concern?

The press coverage concerns the situation where the umbrella companies in question are set up to take advantage of the Employer’s Allowance (EA) which reduces employer NIC by £4,000 per year and the VAT Flat Rate Scheme (FRS) which provides a lower rate of VAT payable to HMRC.  Both of these schemes are not open to all employers because they are limited to smaller businesses with lower staff costs and lower turnover. 

The suggestion in the press regarding MUCs is that certain of these companies are actually associated with one another and are artificial divisions of larger organisations which have kept small purely for the purpose of claiming the EA and VAT FRS.  If these MUCs were actually aggregated due to common ownership, that larger organisation would not be able to take advantage of those schemes.  In other words the MUCs have been structured in such a way purely for the avoidance of tax.

What has been HMRC’s reaction?

This is of course press speculation and HMRC has not commented on specific cases but it must be made clear that in principle umbrella companies themselves are accepted by HMRC as being an important part of the recruitment sector.  This was evidenced by HMRC working with sector representative bodies in late October 2020 to address concerns in the draft IR35 legislation which was interpreted by some in the temporary labour industry as making the umbrella model defunct as there would be no rationale for the umbrella company to operate PAYE/NIC.

HMRC’s views were backed up by the necessary changes in the final IR35 legislation to remove the concerns raised should though be seen as part a wider focus by HMRC on umbrella companies generally.  Within weeks of HMRC issuing their initial statement confirming they would seek the necessary IR35 legislative changes, in November 2020 they also issued a statement concerning the use of MUCs to claim the Employment Allowance and apply the VAT Flat Rate Scheme – both of which are central to the recent press reports. Similarly, HMRC has in the past issued statements regarding the use of contractor loan schemes by umbrella companies which can result in unforeseen tax bills for contractors and other parties involved in the labour supply chain.

Following the recent reports, HMRC has updated and republished its guidance on supply chain due diligence, in particular reminding businesses on the need to understand who is being paid and how those payments are treated for tax purposes.  We agree it is important that businesses have robust procedures in place to know their supply chains, in particular how any umbrella companies or other employment intermediaries in their labour supply chain treat payments to workers for tax purposes not just for the purposes of PAYE/NIC, VAT and IR35 compliance (both ongoing and for identifying historic risks) but also in respect of obligations under the Criminal Finance Act 2017 and the duty to prevent the facilitation of tax evasion.

If you would like more information, please contact John Chaplin.

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