The government has concluded its long-running consultation into stamping out tax and employment rights non-compliance by umbrella companies, meaning the sector is now one step closer to becoming regulated.
In its response to the consultation, the government said it would use a two-pronged approach to ensuring IT contractors (and those working in other sectors) receive the employment rights they are entitled to when working through umbrella companies and are taxed correctly for their work.
The first prong will see the government legislating to define what umbrella companies are, through an amendment to the Employment Rights Bill, which will bring their activities under the watchful eye of the Employment Agency Standards Inspectorate (EASI).
This is a move that contracting market stakeholders have called on the government to make for several years, as the EASI’s remit includes protecting the rights of employment agency workers.
In a typical contractor-to-end-client supply chain, employment agencies often rely on umbrella companies to manage the payroll for the workers on their books, which is why involving EASI appears to be logical move.
On a similar note, the second prong to this umbrella company clampdown will see employment agencies assume responsibility for ensuring the correct amount of Pay As You Earn (PAYE) contributions are paid by their workers when an umbrella company is involved in the labour supply chain.
This change was announced in the Autumn Budget 2024, with the government stating that it expects the move to generate £895m in additional tax during the 2026/2027 financial year by making it harder for umbrella companies to engage in tax avoidance-related activities.
“Where an umbrella company is used in a labour supply chain to engage a worker, the government will bring forward legislation to move the responsibility to account for PAYE from the umbrella company that employs the worker, to the recruitment agency that supplies the worker to the end client,” said the government, in its consultation response.
“Where there is no agency in a labour supply chain, this responsibility will sit with the end client. This will take effect from April 2026.”
The government’s consultation document does, however, acknowledge that some of the steps involved with defining what umbrella companies are, and working out how to regulate them, may not be straightforward.
To this point, it confirmed that no consensus was reached by the stakeholders who contributed a total of 75 responses to the consultation about how best to define umbrella companies.
A topic where some agreement was reached was on what the “substance of umbrella regulations” should be.
“Responses indicated a consensus that the government should concentrate on addressing financial detriments, worker understanding of the umbrella arrangement and ensuring genuine businesses operate in the umbrella market,” the consultation document stated.
As stated in the document, tax avoidance is “widespread” within the umbrella company market, with HMRC claiming that £500m was lost to disguised remuneration tax avoidance schemes during the 2022 to 2023 tax year, which it said “almost all of which was facilitated by umbrella companies”.
The document added: “This tax non-compliance can leave workers facing substantial tax bills and enables non-compliant umbrella companies to undercut their competitors, threatening the viability of those businesses that do the right thing, as well as the functioning of the market itself.”
It continued: “HMRC takes robust action against non-compliant umbrella companies using its compliance powers. However, there is a clear case for strategic action to prevent these forms of non-compliance from occurring at all.”
Crawford Temple, CEO of independent payment intermediary compliance assessor Professional Passport, said the government’s response confirmed much of what was already known about its plans for the umbrella market, as much of it has been foreshadowed.
However, it remains to be seen what the “true impact” of these changes will be, he continued, and more detail on that will come when the draft legislation emerges, which will provide employment agencies with a steer on how much work they will need to do to comply by the April 2026 deadline.
The government needs to tread carefully in the implementation of its plans as any loopholes could simply lead to further exploitation of the rules and another boom in non-compliance Crawford Temple Professional Passport
One area he said the government will need to tread carefully is in how it defines umbrella companies. “Any definition needs careful consideration as any definition can be re-engineered and could open the doors to further non-compliance,” he said. “Government needs to tread carefully in the implementation of its plans as any loopholes could simply lead to further exploitation of the rules and another boom in non-compliance.”
The government first committed to regulating the umbrella sector way back in 2018, so the fact there is tangible progress being made towards this goal is significant, but – according to Temple – regulation and making agencies accountable for ensuring contractors pay the right tax will only go so far.
“HMRC needs to step up, and we know that legislation is not the sole answer and must be supported with visible compliance and enforcement, which has been lacking from HMRC in recent years,” he added.
Meanwhile, Dave Chaplin, CEO of contracting authority ContractorCalculator, said regulation of the sector is long overdue, but the measures being put forward by the government mark a “major step forward” in the fight to protect workers and tackle tax non-compliance.
“Shifting PAYE responsibility to agencies and end clients is a game-changer, ensuring taxes are properly collected before rogue umbrella companies can rip-off workers and the exchequer with non-compliant practices,” he said.
“Regulating umbrella companies will finally bring accountability to an industry that has operated unchecked for too long. The fight against tax fraud and unfair deductions isn’t over, but these reforms lay the foundation for a fairer labour market.”